斑馬技術公司 (ZBRA) 2004 Q1 法說會逐字稿

Good morning and welcome to the Zebra Technologies first quarter earnings release conference call. Joining us today from Zebra Technologies are Mr. Charles Whitchurch, CFO and Mr. Ed Kaplan, CEO of Zebra Technologies. [OPERATOR INSTRUCTIONS] At this time I would like to introduce Mr. Charles Whitchurch, CFO, of Zebra Technologies. You may begin.

Thank you. Good morning, everybody, and welcome to Zebra's first quarter conference call. With respect to the busy time of the season this is for you guys, we're going to limit your questions to one question and one follow-up. We're going to make every effort to try to keep this call to at an hour or less. Of course we will be available for one-on-one phone conversations after the completion of the call. With that being said, I'd like to turn the initial introduction over to Ed, who will begin.

Thanks. Good morning, everybody. Its real pleasure to share Zebra's truly tremendous first quarter results with you today. As you saw from this morning's press release, records abounded. Sales, gross profit, operating income and EPS, among others. By historical comparisons, our numbers are indeed excellent, and we recognize that Zebra has moved to a new and higher plane of business. In short, business was and is very good.

This morning we want to review two items with you. Number one, the excellent first quarter financial performance, which includes 24% sales growth, the best in four years, 27% net income growth, and material improvement in our profitability. And number two, our positioning for future growth. While it's taken us some time to get in the position we are in today, I'm very excited about this current position and quite optimistic about our ability to grow and, in fact, create additional shareholder value. At Zebra's core, we find two operating units that are both well positioned and materially contributing to Zebra's growth. These two units have many things in common and consequently they feed off each other's success and investments. This contributes to our executive advantage, a point I think that is lost by some of our investors.

Within the bar code business unit -- I'd like to make a few comments about the bar code business unit specifically, and that it is, in fact, the industry leader with the strongest brand. The bar code business is more diversified than any of our competitors. We have the broadest product line. We have a multifaceted distribution channel structure with significant revenue coming from each of those different segments of our channel structure. We're global, with significant reach in each region and basically distribution in 90 countries around the world and Zebra outposts in many of those countries. Sales are into a wide range of markets and applications. So basically, we are quite diversified across all of the key strategic dimensions of the typical business. In addition to having a strong core, we are focused on a variety of growth initiatives that have significant potential for us. These include RFID and mobile wireless.

I now turn my remark to the card-imaging group. Zebra has really worked quite hard over the past five years to build its card imaging division. While this division is smaller than bar code, it has outpaced the growth of the bar code unit. From the perspective of product, channel, market surge and geographic reach, we have also moved into an industry-leading position in this business. We provide a range of solutions, including photo ID's, access control, loyalty cards, security applications, and drivers' licenses. And the recent acquisition of Atlantech has moved us into the digital photo printing space. I guess you could see why I like our position in our growth prospects. But I have more to say about this later.

Let me now read our usual disclosure statement. 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 Securities Litigation Reform Act of 1995. In particular, any statements we make regarding our financial forecasts for the 2004, second quarter on 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 in the press release issued today by Zebra as well as Zebra's filings with the SEC. In particular we direct your attention to the company's Form 10-K for the year ending December 31 of 2003.

Now back to business. For the second quarter in a row, sales topped our most optimistic expectations up $4m over the upper end of our guidance range. In a period normally down from the fourth quarter, sales were actually up $7m on a sequential basis. Our business in the first quarter was impressive, not just for its scale but for the absolute amounts of sales growth up more than $29m from a year ago. Increasingly, our business has benefited from our solutions orientation, driving demand and fulfillment, the demand through healthier, more diversified channels. These efforts are complemented by geographic expansion, the economic recovery, and the success of our new products. Sales growth for the first quarter was broad based. Activity was consistent throughout the quarter. Sales were exceptionally well balanced across products, channels, and geographies. Let me explain.

We saw sales growth in all product lines. Every printer category was up, with most up more than 20%. Mobile printing systems and important elements of our growth strategy saw continued strong sales growth in addition to the ongoing success of the Z series table top printers and the recently introduced 110-Xi III plus high performance laser printers. Card imaging products also maintained its strong growth profiles with sales into a variety of commercial and security applications worldwide. The strength of our product line demonstrates the effectiveness of our commitment to product innovation. For the first quarter, 29% of printer sales were derived from products introduced over the previous 18 months. Nearly all channels participated uniformly in our growth. This consistency speaks to the variety of our worldwide distribution. The improving vigor of our partnerships and the viability of our distributions to give us deeper reach into smaller, high velocity bars, and the effectiveness of key account sales.

All geographic territories were up sharply with sales records set in Europe and Latin America. Both Asia Pacific and Latin America continue to benefit from our geographic expansion programs placing additional sales representatives in high-growth regions. In Europe we achieve an impressive 33% growth. North America, our largest territory, saw further acceleration in sales growth to 17%, up from 12% in the fourth quarter and 5% in the third quarter. North American sales were up $12m from a year ago and$4m from the fourth quarter. In addition to a more robust US economy, our partners first channel program introduced in July has gone a long way toward strengthening channel relationships and capturing greater mind share from a more diversified group of resellers. Our program has improved the business model for established channel partners and continued to attract new bars, integrators, and software developers. We have now signed about 200 of these new channel partners, up from only 100 six months ago.

In addition to record sales, the improved profit margins contributed to the record earnings. Gross profit margin reached the third highest level in the history of the country. And we had record operating income even as expenditures rose to support RFID and other long-term growth initiatives. We generated a near-record $30m in cash for the quarter and ended the period with $488m in cash and investments on the balance sheet. Our results for the first quarter sum up to this -- the effectiveness of our growth strategy and the increasing strength of the Zebra brand. Because of our products, channels, and programs, we are increasing Zebra's name recognition and attracting more business every day. Our strategic leadership has never been stronger, nor our vision more clear. We are exceptionally well positioned for continued growth, both through the established regions of our business that are driving business today and the emerging areas that will have more meaningful effect later this year and into next. Following Randy's remarks, I will give a brief update on our position and further growth and the status of our RFID activities.

OK. Thank you and good morning everyone. First quarter results were really outstanding. Record sales and net income, near record growth profit margin and30% growth in operating income, which also set a new record. It's really hard to find a weak spot anywhere in first quarter sales or anywhere on the PNL. Let's start with some details of the sales results.

Hardware sales in the quarter were$118,477,000, which was an increase of 25.3%. Supply sales were at $28,674,000,up 23.9%. Service and software sales at $6.5m, up 3.8% and the balance of our shipments were compromised of shipping and handling and the results of hedging activities in the quarter. Our total sales were $154,174,000, an increase of 23.7% over a year ago. I'd like to make a couple of additional comments at this point. First of all, in supporting what Ed said, order rates were consistently strong throughout the quarter, which not only drove our sales growth from a year ago but enabled balanced production throughout the quarter which helped us improve our profit margins. Also speaking to the strength of our business is that our sales increased 4.7% sequentially in a quarter that is normally down. Within hardware sales, we had remarkable consistency in growth across virtually all categories, from hybrid performance printers to print engine mobile and card imaging products. Card imaging aided by the Atlantech acquisition in November had a record quarter. We are very encouraged by the strong quote in our supplies business.

From a geographic perspective, European sales were $52,452,000, an increase of 33.4%. Latin American sales set a new record at $8,439,000, an increase of 26.6%. Asia Pacific sales at $12,150 were up 33.1%. These regions combined to result in international sales of $73,041,000, an increase of 32.5% over last year. North American sales of course, which is our largest region, were $81,133,000, up16.6%. Like the broad participation of all products in our growth, all regions contributed importantly to our record results. In Europe, a strong euro and pound continued to aid record sales there. The change in exchange rates, net of pricing adjustments had a positive $3.4m impact on quarterly sales growth.

On a consolidated basis, the combined impact of foreign exchange gains and the incremental sales from the Atlantech acquisition in November boosted sales by 5.8 percentage points leaving an organic growth rate of 17.9%. I think it's safe to say our core business is doing very, very well indeed. I expect that we will continue to benefit from exchange rate gains throughout the third quarter, unless, of course, there is a dramatic reversal in exchange rates. Our international growth is clearly benefiting from our strategy to increased in-country staffing that we put in place over the last several quarters, particularly in China, where we will be adding additional head count and opening new sales offices in the bombing quarters.

With the 16.6% growth for the first quarter, North America was the slowest growing region but the second largest in absolute terms, increasing $11.6m over a year ago and $4.6m from the fourth quarter. As Ed mentioned, the U.S. economy and strong acceptance of our partners first program, as well as the increasing success of our solutions orientation, helped accelerate sales growth to the third consecutive quarter. Gross profit margin increased in the first quarter to 52.3%, an expansion of 0.7of a point from a year ago and 0.8 from the fourth quarter. Higher capacity utilization, cost reductions, and favorable exchange rates all contributed importantly to this result.

Operating expenses were up $7.2m from last year, up 22%, but less than our sales growth at 23.7%. Major sources of the increase came from higher head count, mostly engineering, and many of those from the Atlantech acquisition. Legal expenses and payroll taxes related to 2003 bonus payments and stock option exercises as well as exit costs related to Barad and Warwick. Higher sales and expanded gross margin and controlled growth in operating expenses delivered an operating margin of 26.4%, up 130 basis points from a year ago, and the best margin since the third quarter of 2000. Operating profit increased almost 30% to a record $40.7m, and includes $400,000 of exit costs related to the final stages of closing our development facility in Barad, France, the consolidation of mobile printer manufacturing, and the move to centralize north American service operations in Vernon hills. We expect these moves to lower costs and improve customer service, beginning in early 2005.

Fourth quarter investment income was $3.1m, equating to a 2.7% return on beginning balances. And as projected on our last call, our tax provision rate dropped by 25% to 34.75%. First quarter net income of $27.9m was 58 cents her diluted share and a new record for the company and an increase of 26.7% over a year ago. Sequentially, net income increased 14.5%. Free cash flow for the quarter was $30.4m. Even with a significant sales increase, receivables were up only $237,000 from year-end because day sales outstanding were down to a record low of 48.6 days. Inventory turns declined to 6.1 from 6.8, partly because of bills to support orders for shipment early in the second quarter. We are very optimistic about our growth prospects. Business is excellent.

Our strategy is working. Our competitive and financial position has never been stronger. We expect continued high growth in the second quarter with sales growth of between 18% and 23% to a range of $154m to $160m. Quarterly earnings are expected to be in the range of 54 cents to 59 cents a share, up 15% to 29% from a year ago. This forecast implies a gross margin in the range of 51% to 52.5%, and operating expenses of between $41m and $43m. I conclude my formal remarks. I thank you for your attention. I will return the call to Ed for some concluding comments.

Clearly, the high level of optimism for growth we expressed in our conference call in February is turning into reality. The strength of our core business is impressive. Capital spending on manufacturing and IT infrastructure continues to improve with a stronger US economy. Our global expansion program is delivering ever-higher levels of sales at the representatives placed in high-growth regions in the last several quarters mature in their positions and become more productive. More representatives will be added this year to support future growth. The outlook for future card printer deployments remains positive and mobile products continue to achieve a high growth profile as wireless technology moves into the mainstream.

Our optimism also stems from the progress in initiatives that will add another layer of growth in 2004 and beyond. Our results for the first quarter show, however, that Zebra's growth does not depend on any one single initiative. The diversity of our business across geographies, products, channels, provides remarkable res urgency in sources for growth. You are already aware of our plans to continue with our highly successful international expansion program. Digital photo printing remains a long-term opportunity that continues along its development track, and our vertical market initiatives are beginning to show results. Of all the areas in which Zebra is involved, the investor spotlight has shown most brightly on RFID.

At our February conference call, we gave you a detailed update of the state of Zebra's employment and benefits from it. Since that time we have increased shipments of our out fall and plus EPC RFID printer encoder to support the growing number of pilot programs underway in preparation for full deployment of technology next year and beyond. Recently, Wal-mart reaffirmed its commitments to begin RFID deployments on 1105, and more retailers such as Albertsons announced their plan to adopt the technology. The department of defense continues to move forward with its initiative. Zebra has joined the DOD vendor advisory group, which is establishing RFID standards and procedures with the DOD.

During the first quarter, we increased staffing for RFID by 50%, adding resources and engineering, technical support, and product developments. We also strengthened our ties with systems integrators and other strategic RFID decision makers and formalized our RFID channel programs. With the broadest technology portfolio combined with the deepest experience in auto ID solutions and our relationships with manufacturers and integrators, both at the global and local levels, we are confident that Zebra is well positioned to benefit from the coming adoption of RFID technology.

We appreciate your continuing interest in Zebra. Indeed, the future is bright. Core bar coding and card imaging technologies and products supported by a stronger brand are being deployed at higher rates through robust channels and a more effective Zebra organization that is driving demand. Activity to expand our global presence further position us for growth in RFID and benefit from capturing opportunities in vertical markets, only to add to the outlook and our optimism. We would now be very, very happy to respond to your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Jeff Rosenburg with William Blair.

Good morning. First question, you mentioned in the press release you're seeing some improvements in average selling prices and I wonder that Randy, if you could talk about the effective mix on gross margins. It sounds like from the fact that all product categories are doing so well that maybe you will see some strengthening at the high end. I'm curious whether or not that is accurate inference.

Yeah, we had very good results across all parts of our product line. We definitely had strong sales at the high end of the printer range. I would not say that mix was a material contributing factor to the improvement in margins because we had quite balanced growth, actually, across the entire product line. As I mentioned, the major factors improving our margins related to capacity utilization, exchange rate gains, and some element of cost reductions. Of course, the cost reduction programs are ongoing. Among those, I would include the exercises we're going through right now to consolidate our service organization and our manufacturing of mobile printer products, which we believe will enable us to further improve gross margins beginning in 2005. Of course, in the interim, we're incurring some additional costs. I would actually say that right now you're margins are being held back somewhat by some of the costs we're incurring to make these moves, which, of course, are temporary costs and will be eliminated when the moves are complete.

That's helpful. Thanks. To follow up, I wanted to ask an RFID question. Ed, I wonder if you could comment a little bit on standards development and as we move towards getting a generation two standard from the EPC. How does affect the competitive landscape for Zebra what does that mean in terms of do you have anything that is important to you relative to how those standards turnout or maybe some commentary as it relates to the industry and how that will affect the rate of adoption? Thanks.

Certainly the adoption of standards is important for everybody in the industry, and also, obviously, the sooner the better. There are various constituencies that will benefit from the standard becoming A, B, or C. In the case of Zebra, it really doesn't make much difference in terms of what it is we're doing. The availability of various components that are used in printer encoders that are used in smart labels, you know, their availability is influenced by the adoption of those standards. All of our competition faces exactly the same situation. People have dealt with this in a variety of different ways. I don't think we're in the product category where the effect of the standards is going to put us at any particular competitive disadvantage to anybody else that's in the marketplace. I wouldn't say that if I was in the-- if I wasn't in the reader business or if we were in the chip business. I think those people are very much affected by standards and their individual abilities to respond to those standards.

Does it have any effect on the new product cycle, sort of speakers you have to update the RF4M and its variations?

Absolutely, but I think we're on a level playing field with competition. You-- in terms of the encoding and the subsequent reading of the encoded information, you need to know what the protocols are in order to implement that aspect of our design. So when those things are solidified, we will be able to then ship product that complies. We're in a situation right now with EPC global that really no one really knows what the output is going to be from their efforts. There is lots of speculation as to what that output might be. You can hedge your bets by dealing with that speculation if you have enough resources, but that is a very important event.

OK. Thanks a lot.

By the way, I think they are -- their timetable for completing that has been moved out a little bit.

Moved out from September that they said recently?

I actually don't know the dates. September 20 or something like that? I have forgotten. At any rate, that is a very important date for everybody in the industry.

OK. Thanks a lot.

Your next question comes from Peter Berry.

Hello, gentlemen. Ed, as we look at the linearity of the quarter and also - seems to be the pattern on normally in Q1 versus what it usually does, do you think that's more a measure of the macro environment or a measure of the success of the partners first or is it a blend of all of that? And do you think it's a sustainable environment?

Well, there are three questions there, aren't there? It sounds to me like you already used up for the Q 2 report.

I have a follow-up, if you don't mind.

Yes, indeed. I already forgot what you asked. What was the first question?

Linearity and then quarterly pattern, is that more a measure of the overall environment?

I think it is both. I think that what we have is -- what appear to be people who have delayed implementation of programs that are now releasing those programs in anticipation of a stronger economy that can support their individual businesses. There are several examples of that with orders that we have received. So we have the -- that's really -- it's an economic effect that's freeing up business programs that were stopped, some of them years ago. So I think that is the big factor. The other factor for Zebra is during the downturn, we invested heavily, and so the scale of our organization on a global basis and the products that we have in the marketplace put us in a stronger position relative to competition. It will be interesting to see here in the earnings season, Q1 season, as to how each of the folks in the auto ID sector, how they report. But I suspect that we will have done on a comparative basis quite well. But there are definitely signs that others are doing well. I'm not sure as well, but doing well.

So is it fair to say that within any given quarter, the linearity is getting better and better?

I would say that in this particular quarter, we saw right out of the chute a really good flow of business and that flow of business sustained itself through the entire quarter. That is a relatively unusual thing for us. It is, of course, pretty normal to see things pick up toward the end of the quarter. That I attribute to the absolute persuasiveness of our sales organization. But on the other hand, we have had quarters. It's not uncommon for us in the fourth quarter to have things fall off into December because of the holidays and people's holiday spirit getting ahead of their buying habits. But this first quarter, the fact that it is up from the fourth quarter and the fact that it started out so strong is really an unusual thing for us to see. I don't know what all the reasons are, but we certainly are happy about it.

And my follow-up question. The sustainability of March gins at what is clearly a historic high level. The restructuring certainly will help. But in the normal course of business, do you think we're at a new plateau that relates to both gross and operating margins?

We have been predicting for 12 years that margins are going to go down, and we obviously don't know what we're doing because they are going up. Peter, it's always hazardous to predict out margins. I think there is a variety of things that were clearly benefiting from obviously we are, we work very hard at cost reduction programs. Clearly, the increasing levels of capacity utilization are helping us out. Our facility costs are relatively fixed and we're able to spread those costs over a larger activity base, and that clearly benefits us. The big wild card in all of this is what's going to happen with exchange rates, and nobody can predict that. Fundamentally we have -- there is no doubt we've benefited from it over the past year. We're grateful for that. We know at some point that's going to change. But in the interim, we're very pleased with the results that that helps us deliver. I think it's fair to say that in this first quarter, there are a variety of things that are actually driving margins down, one of which is the Atlantech acquisition. We acquired a company whose margins were not as good as Zebra margins. We have the ability and have demonstrated that in the past with acquisitions that we've made to have a relatively quick ability to improve the margins on the products of companies that we acquire. So I would anticipate that this quote, unquote, drag in the first quarter would be gradually or rather quickly improved. As well as we will over the course of 2003eliminate the additional costs, we have to incur to go through this consolidation exercise we're going through now. Those are a couple of things right there that is going to be improving moving margins upward from where they currently are. What things are going to move it down, gosh, I don't know. There is a competitive pressure, there is exchange rates, a variety of other things. We did give some guidance on profit margins, and I'm going to stick with that guidance.

Let me tag on to just one thought to what Randy said. It really was part of my opening remarks that I made. That is the fact that Zebra is in the card business, card imaging group, and we're also in the bar code business, in addition to that, we are now into photographic printing, and we are in terms of expansion --and we're in RFID. The point of all of this is that the scale of our business and the leverage we have with our vendor base is able to be applied across these business divisions and able -- and the relative scale of each of these divisions relative to their competitors is an important differentiator between us and our competition. And so we're in a favorable position relative to overall scale in terms of manufacturing printers that utilize thermal printing technologies. I mean, virtually every printer we produce for all these different applications utilize thermal print heads. So you might imagine that we have something to say to the companies that are providers of print heads. So this continues through other kinds of elements that are used in our products. The platens that are driving material through the printers. Platens are used in virtually all the products. So the commonality of parts and types of are used in virtually all the products. So the commonality of parts and types of parts spread across these different businesses and the relative scale of our business gives us an advantage, and that's a piece of the equation as it relates to margins.

Thank you both.

Your next question comes from Kevin Stark with Bear Stearns.

I'm not sure why that's still happening. I'm actually with Imperial Capital. I missed you very, very much. I have just a simple question. CAPEX used to be about 5% of sales in the late 1990's. It has been less than 2% ever since. Do you think it eventually might back up to higher levels or is this a good level to model forward?

You said it's at 2%?

Thereabouts, less than I think. 1.8 something like that.

I will let Randy respond.

You're right. CAPEX was -- the exact figure was 1.9% in 2002 and 2.1% in2003. This quarter, actually, we had $5m of CAPEX. The majority of that was related to some facility work we're doing in Camario. We spent money on hardware and software parts and then there is new tooling for new products that are coming out. It's hard to say. I mean, obviously where a company is not capital constrained. I mean I wouldn't characterize us as putting a cap on what we're going to spend on capital expenditures, but we're right now on a course to spend in 2004 somewhat more than we did in the prior two years. I would say maybe roughly speaking 3% of sales. That would be a reasonable number I think for this year.

A follow-up question completely unrelated. In the photo printing business, can you identify who are the key competitors there and any kind of sense of the market you could give us?

Well, the aspect of the market that we're involved with is digital photo printing, and the focus of our activity is in the professional segment of the marketplace. These would be, for example, studios that are operating in digital format instead of analogue and have the ability within their studio to convert the electronic images into eight by tens immediately for their customers. So that's the segment that we participate in. There is hardly anybody else in that professional space. We're in the professional space because of the relationship that we have with Kodak. With that said, we do intend to extend our position within the space to other-- to other market segments. And the key -- the competition comes in, let's say, two forms. One form are people to utilize dye diffusion technology, which is by many felt to be the superior technology from the standpoint of life and the quality of the image that's produced, the depth of the image. So that's a technology that we're using in this professional printer. And it's the technology that you will find in a lot of the kiosks that are found at your corner drug store -- Kodak picture makers, etc. So we have expertise in this area of dye diffusion. The other technology that is very prevalent within the digital photograph arena is ink jet, and ink jet is being used a lot in the home marketplace. So the competitions within dye diffusion are primarily the Japanese-based companies, by people like Mitsubishi, Sony, a whole lot of them. Maybe a half a dozen companies that are found in various products around the world. Cannon, by the way, offers a dye diffusion product, but that's actually for the home marketplace. So that's the way thing are set up. By the way, the competitors in the ink jet side of this are a mixture of US companies with -- in the United States Lexmark and Hewlett-Packard being the largest and the others are people like Epson and Cannon, etc., who are competing for that space.

Thanks very much.

The next question comes from R. D Pai.

Good morning, gentlemen, and congratulations on a great quarter. Two questions. The first is about your expense line. I see that your sales and marketing expenses dipped down from the fourth quarter to the first quarter despite the higher sales. I was trying to figure out by going forward how we should be thinking about that? And then the second question would be looking at your card imaging and also printers with the wireless, at what rate are those businesses growing? And can you give us a rough size as a percentage of revenues where they would be. I know you don't want to give too precise a number there for competitive reasons.

Relative to the expense, I will let Randy handle that. In essence, the growth rates that are in the various segments of the marketplace are not information that I have got available for you.

As far as the sequential change in the sales and marketing expenses, that really is driven -- the change was really driven by the peculiarities of our commission structure and how bonuses tend -- commissions tend to accelerate at year-end. It really doesn't speak to any -- anything with respect to changes in the sales level first quarter versus fourth quarter. It's the way the commissions are actually structured. And as far as breaking out the individual line items on the operating expense side, we really -- we don't do that anymore, we used to. The guidance that I gave you earlier in the call is what we would stick with, and I believe that was 41 to $43 m in overall operating expense.

OK. Thank you so much.

You are welcome.

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

Good morning, guys. Excellent quarter. I know your stock price hasn't lacked for appreciation, but I'm wondering if you have looked at the situations with value line and MGM declaring these special dividends and do you have any thoughts to do anything of that nature?

We don't have any plans to issue a special dividend or a regular dividend.

Then, second question, usually comment on how large scan source is of your business. Can you do that?

Yeah, scan source was a little over 13% of total sales in the quarter.

OK, great. Thank you.

Your next question comes from Rick Sean(ph) with Cars Capital(ph).

You talked about one of the pressure points in the margin eventually at some point being the international FX. Can you talk about how much that has benefited you guys to date?

I indicated in my comments that the foreign exchange in the quarter roughly was about $3.4 m of impact.

On EBITD or on revenue?

On revenue. A good portion of that drops right through to EBITD because a very small percentage of our expenses are euro dominated. And for example, roughly 80% of our sales out of Europe are euro denominated and single-digit expense levels. So, you can see that any change in exchange rates will affect revenues and there won't be a corresponding offset on the expense side. So you're going to see a relatively similar impact going down the PNL.

So look out a year, two years, three years, and you start to sell more RFID printers, which are more advanced, higher priced points, clearly high expense, but I would imagine they should be higher margin printers. To what extent will you decide to reinvest some of that increased gross margin into R&D? Or you left that first to PNL, how do you think about that?

Basically, we invest in R&D as we see the opportunity to invest in R&D. And I don't -- the -- frankly, if I saw a really big opportunity, I would -- and I liked it, we would jump at it. We will look at it more from the perspective of perhaps a short-term blip in terms of the expense we incur in R&D and relative not necessarily changing the business model. But we would not hold back in terms of doing that. So improvements in gross margin I wouldn't be looking for those to be funding increased R&D.

So it is possible that even though you're at the 26.5% EBIT margin, barring some change in FX, it is possible from here that this is not the Max level. There are still opportunities from here as it pointed out?

Yeah, there are opportunities. But it definitely goes both ways.

Great. Thank you very much.

Yeah.

Your next question comes from Mike Whitfield with Wachovia Capital.

You danced around the question quite a bit on gross margin. Are there specific thing in the second quarter that will cause a sequential decline?

Not that I'm aware of.

OK. I just wondered why you -- the guidance you have given is below the figure you just reported, and given the other commentary you just mentioned, I'm wondering why the guidance is sequentially down for gross margin.

Well, again, it's an issue of when we project out the gross margin, we look at the projected sales and of course the mix of sales is going to have some impact on our views on gross margin going forward. So I guess its -- our projections indicate that there is a potential for a sequential decline. Now, whether that happens or not, obviously, is TBD. Quite honestly, it is not a significant change. And if you look back historically, gross margin has moved around. It goes up, it goes down, but it doesn't go up or down by very much, and the trend overall has been up. So I think let's factor that into our thought process here and recognize that everything doesn't go all the way -- doesn't go up every quarter. Sometimes they are down, sometimes they are up, but again, our performances in this area I think have been pretty respectable.

I will concur with that. Ed, I was wondering if you could talk briefly about your expectations of recent FDA mandates and how that impacts business?

They are terrific. This is great. I mean, the -- if, in fact, the companies that are focusing on bedside administration of drugs get their systems - get their product designed and their marketing efforts, focus on those marketing efforts, the improvements that you can have in terms of bedside administration of drugs are dramatic. Zebra is able to participate in that in several different ways, which of course, makes it very exciting for us. We have equipment that allows us to put bar codes on the drugs that are being administered, and that can be done at a variety of places, including in terms of in-hospital pharmacies. Secondly, you have got the ID systems that are used on the employees, doctors and nurses. We make photo ID cards. We sell into the hospital marketplace. And those ID cards are a key element in the information systems because they will be scanned at bedside. And lastly is patient identification. We're in the business of making printers and selling supplies for wristbands. Those wristbands have bar codes on them as well as alphanumerical identification. So the three elements of data entry that would be manual are all bar coded in Zebra manufacturers equipment that is capable of doing that barcoding. So while we're very, very thrilled about the mandate, and the other point to realize is -- it's a poor situation. You know, being a -- living in the United States, but the reality is this kind of technology has existed for a while and that it has not been implemented and that there are lives that are lost, just about daily because of these kinds of mistakes that are, in fact, can be reduced and by and large are avoidable. So it's great news that the FDA is mandating the identification with the bar codes. I would like to have seen them go further. I would like to have mandated that in fact you install a patient identification system and drug identification system for bedside administration of drugs. They did not do that. They only went as far as mandating the labeling of the drug. It's still up to the hospital to making decisions relative to implementing the systems at the bet side. But I do -- there are a number of companies that are developing systems in that area.

Can you comment on what your expectation is of a timing might be when you guys might be with some type of material benefit?

We do see benefit now. I can't quantify for you the timetable on the amounts. We're not in a position to do that. I can tell you that if, in fact, --I think it's less than double digits. Below 10% is the amount of bedside systems in the United States. So you have here a huge market, someone in the room here is waving two fingers up. I think that means 2%. You have a totally untapped marketplace. It's a matter of people getting on the bandwagon. It could even reach the point if some hospitals start putting in these systems that patients will prefer one hospital over another because of the -- you know, the pervasive knowledge that there is a problem here. By the way, there is also work going on not only at bedside but also in the operating room. It's actually a more severe situation in the operating room because of the general circumstances that prevail in an operating room versus getting a drug at your bedside. The administering of drugs by an injection in particular is a real problem. And there are a few companies out there that are working in that area.

Thank you very much.

Sure.

Your final question comes from Hassan Karim (ph) with Pacific Edge.

(inaudible) effects on one on the card imaging business. In terms of your forecast for Q2 on the Euro dollar or pound dollar rate, what are those and is that one of the reasons why the guidance for EPS is lower? And then the second question, I think you might have skipped over this, but what percentage of sales is now the card imaging business? And does that have an effect on gross margins going forward?

Let me comment on the effects question. That is not the reason why our guidance is lower. I think if you look at the -- our assumption that basically our exchange rates will be roughly in the second quarter what they were at the end of the first quarter. And the guidance is somewhat lower because I think if you will notice, we did have a range on the gross margin which a previously question noted that was somewhat lower than the first quarter actual results, and there was also a somewhat of an uptick in the operating expenses, so those are the two reasons why the guidance is where it was, where the guidance is, rather. 59% I see is where we ended up (inaudible). Ed, do you want to take care of the -

Sure, the question on card imaging?

Right.

You were looking for a breakout of what percentage it is of our total sales.

Roughly, and impact on gross margins.

The gross margins are good in that business. They are not quite as strong as it is in the bar code business. However, the breakout of the sales is not something we have historically provided.

I guess in terms of the recurring business and the card business and the card imaging business, the supply-side, is that better than gross margins.

For sure I won't break that up. Try going higher but not lower.

OK. So in terms -- I think it's around 15% to 20% was what people were saying. Is that about right for the card imaging business?

That's what people tell you. Are those dependable people?

Is that in the range?

Ask those people. You're not getting it from us.

Let me make a general comment from the recurring revenues in supplies as it relates to printers. Sometimes it is a surprise to people to realize that the printer hardware that we manufacture has much higher margins than the supplies that go through those printers. So you have got to start from that position overall. The same situation prevails on both the bar code side and card imaging side. We make better margins on the hardware than we do the supplies that go through the hardware.

OK. Thank you. I think

OK. Thank you. I think we're pretty much at our hour limit. You guys have a lot of calls you're taking today. It's a very busy time of the quarter for you. We're going to conclude the call at this point. We will, of course, be most interested and most eager to answer your one on one phone calls should you have any additional questions. In the absence of that, we're going to say goodbye until the second quarter conference call, which is currently scheduled for the third week in July. We look forward to talking to you at that point.