斑馬技術公司 (ZBRA) 2004 Q2 法說會逐字稿

Good morning, and welcome to the Zebra Technologies second quarter earnings release conference call. Joining us from Zebra Technologies, are Mr. Charles Whitchurch, CFO, and Mr. Ed Kaplan, CEO of Zebra Technologies. All lines will be on a listen only mode until after today's presentation. Instructions will be given at that time, in order to ask a question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objection, please disconnect at this time. At this time, I would like to introduce Mr. Charles Whitchurch, CFO of Zebra Technologies. Sir, you may begin.

Thank you, and good morning, everybody. Welcome to the conference call this quarter. I'd like to start with some formal remarks, and when we do start the Q&A, we would like to limit everybody to one question and one follow-up question. I'll turn the call over to Ed at this time.

Thanks, Randy. Good morning, everybody. And thank you for joining us today, to discuss our second quarter results and, of course, the outlook for the balance of the year, and beyond. We, of course, are quite pleased with our record financial performance, and the effectiveness of our strategic plan. By any measure, our results were excellent and filled us with great optimism for the balance of the year. Sales and earnings growth accelerated. Sales, gross profit, operating income, net income, and EPS all hit new records. Profitability improved, even as we increased investments in RFID and other areas to support long-term growth and stockholder value creation. Some of the key points follow.

Our second quarter results were broad based. The features that characterized the first quarter, balanced growth across product lines, channels, and geographies remained intact in the second period. In addition, we set records in many product categories and geographic regions. Secondly, the strategy laid out earlier this year, is working well for us. The strength of our business at the end of the quarter, gives us outstanding start into the second half of the year. Thirdly, in RFID, placements have increased materially. A variety of companies have launched their pilot programs with Zebra products, and early results are quite encouraging. Lastly, we materially exceeded expectations for the first and second quarters of this year. Taking advantage of the strength, we've decided to increase investments further in several high-growth areas to extend our competitive leadership. In the second half, we'll be increasing expense budgets in RFID, card imaging, mobile wireless, and global expansion.

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. In particular, any statements we make regarding our financial forecasts for the 2004 third quarter, and expectations about trends in the Company's business will be forward-looking statements. The forward-looking statements involve risks, uncertainties and other factors that could cause 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 filings with the Securities and Exchange Commission. In particular, we direct your attention to the Company's form 10-K for the year ending December 31, 2003.

The second quarter was another period of superior financial performance. Sales were up more than 25%, operating income up 37%, and net income up 32%. Consistent strength from the beginning to the end of the quarter, led the results to top the upper end of our guidance range. Sales increased more than $8 million over the strong first quarter, and $33 million over the second quarter of last year, for the best growth in 4 years. Our European, Latin America and North America regions achieved new sales, as sales in all regions were characterized by steady order flow. We did not rely on a few large orders to make our numbers. Just as in the first quarter of this year, new products, focused marketing and better geographic coverage were very much a part of our second quarter growth. Simply put, we executed well on all fronts.

Notable within very strong and deep second quarter business activity, were shipments into an expanding number of retail applications. Many of these in-store applications involve mobile printers. Four years ago we acquired a leading position in mobile printing and wireless technology capabilities. Since that time, we have developed a product line and taken advantage of our global channels to extend mobile printer distribution. Today, we are seeing the financial benefits of the strategy.

In addition to applications within retail, we are now seeing sales of mobile and wireless printers into a wider variety of applications, such as warehousing and manufacturing, as a result of targeted marketing and sales efforts. The outlook for further growth of mobile and wireless printing is quite bright. We are clearly operating in a favorable environment for the continued adoption of bar coding. As global businesses continue to expand, companies are increasing the use of auto ID technologies, going deeper into the enterprise to achieve process improvements.

Within this favorable environment, our business strategy is working to enable us to win more business. We are leveraging our market share, install base, and leading competitive position. Our brand name is attracting more customers and business opportunities than ever before. We are amplifying our success with more efficient demand creation activities, and fulfilling that demand through more robust, expanded, and economically healthier channels.

Now, here's Randy to give a detailed review of second quarter results, and the outlook for the third quarter. Following his remarks I'll return with some brief comments on RFID and other growth initiatives.

Thank you, Ed, and good morning, everyone. Similar to the first quarter, it's really quite hard to find any weak spots in our financial results. So let's go over the details initially of our sales results.

Hardware sales were 127, $167,000, -- $127,167,000, an increase of 29% from a year ago. Supply sales at $28.273 million were up 16.8%. And I might note here, that the combination of hardware and supplies were up 26.6% over last year. Our remaining product categories, which include service and software, shipping and handling, and a small amount of hedging activities, were up approximately 4.2%.

Total sales, $162,830,000, up 25.4% over a year ago. Within the hardware category, we had sales growth in all product lines. Every printer category was up. Most notably, mobile and wireless printers and card imaging products, both of which had record results for the quarter. In our mid range series, our Z-series platform performed exceedingly well, also setting a new sales record.

The strength of printer sales across all product categories, including continued strength and high performance in desk-top models, reflects the broad range of applications into which our products are being placed. And as tangible evidence of the competitive advantage provided by the breadth of our product offerings, for the second quarter, 28% of printer sales came from products introduced over the prior 18 months. We remain very encouraged by the continued strong growth of our supplies business.

Geographically, [inaudible] sales were $53,156,000, a growth rate of 24.9%. Latin American sales were 9,452,000, a growth rate of 31.5%. Asia Pacific sales were 12,039,000, a growth of 20.4%. Which brings international sales to a total of $74,647,000 and a growth rate of 24.9%, making international sales of 45.8% of second quarter results. North America had $88,183,000 worth of sales, a growth rate of 25.8%. The total sales, of course, being up 25.4.

The big story here is the continued story is the continued acceleration and the growth of North American sales, which were up 25.8% compared with 16.6 in the first quarter of 2004, 11.5% in the fourth quarter of 2003, and 5.2% for the third quarter 2003. We're clearly benefitting from strength in the U.S. economy, combined with increased traction for our vertical market and channel strategies. Asia Pacific and Latin American sales are benefitting from our geographic expansion program, of placing additional sales representation in high growth national markets, such as Mexico, Brazil and China. The success of this program is particularly evident in China, which has had some of the highest growth of any country that we cover, since adding sales representatives and engineers late last year.

Foreign exchange had a positive, though diminished effect, on our sales results in the quarter. Net of price adjustments, exchange rates had a positive $1.9 million impact on quarterly sales, and contributed 1.5 percentage points to year-over-year sales growth. We expect a benefit though, to diminished rate from exchange rate gains through the balance of the year, unless the dollar strengthens significantly from current levels. Excluding the impact of foreign exchange, and the Atlantic acquisition, Zebra's core growth for the quarter was 21.5%.

Gross profit margin of 51.9% is up 6/10 of a point from a year ago, and within our expectations. Higher capacity utilization, product cost reductions, and favorable foreign exchange rates all contributed to this result. Operating expenses were up 18.2% in the quarter, again, within expectations. The largest area of growth occurred in engineering for product development projects, including RFID printer encoders, and an administration for legal expenses relating to litigation, additional work we're doing on intellectual property, and international. We also incurred $876,000 in exit costs related to Varad and Warwick. Higher sales, expanded gross margin, and moderate growth in operating expenses delivered an expanded operating margin of 26.5%. An overall operating growth and income of 36.9% including exit costs.

Second quarter investment income was $2.1 million, or a 1.7% return on beginning balances. Second quarter net income of 2 hundred -- $29.4 million, or 61 cents per diluted share set another new record for the company, and represented an increase of 32.2% over a year ago. Sequentially net income increased 5.3%. Free cash flow for the quarter was $7.4 million, caused by 2 tax payments, and an increase in receivables. Receivables are up $13 million from the first quarter, exclusively because of the strength of our business in June compared with March. The strength caused day sales outstanding to increase 5 days to 53.4.

Inventories showed a marginal decline from the end of the first quarter, despite higher sales, which boosted inventory turns of 6.6. We're very optimistic about our growth prospects for the second half of the year. The strength of the quarter carried through to the end, and we began the 3rd quarter with an excellent order backlog.

We expect continued high growth in the third quarter, a sales growth of 20 to 25%, to a range of 162 to $168 million. Quarterly earnings are expected to be in the range of 59 to 64 cents per share, up 23 to 33% from a year ago. This forecast implies a gross margin in a range of 51.5 to 52.5%, and operating expenses of between 41 and $43 million, including exit costs. As we stated in today's press release, the third quarter is seasonally comparable with the second quarter. That concludes my formal remarks. Thank you for your attention, and I'll turn the call back to Ed at this point.

Thanks, Randy. Those are really staggering financial results. We enter 2004 optimistic that our business strategy would build on our accomplishments in 2003. Unquestionably, our results have been terrific.

The strength of our core business built steadily through the first half of this year, new and established products are receiving excellent acceptance in a growing number of business improvement applications, international operations are benefitting from the increasing productivity of sales representatives placed in high growth regions, the impact of Partners First Channel Program introduced one-year ago is also evident. On top of all of this, we are achieving high growth in card imaging products, which we entered in 1998, and mobile and wireless printers, which we entered 2 years later. We've also made steady progress in deploying vertical market applications. These 3 areas continue to offer exciting, long-term potential for Zebra.

Let's now focus a bit on RFID. RFID continues to draw the greatest amount of investor attention. During the second quarter, we made further progress positioning Zebra for leadership in deploying the technology. At Zebra, leadership begins with products. During the second quarter, we introduced 2 RFID printer encoders. The 2844-Z is a high frequency product targeted at emerging health care and small package delivery applications. For supply chain applications, we introduced the R-110 XI 3, the industry's first and only EPC class zero and matrix class zero plus product available. Earlier this month we introduced an RFID ready printer, which offers bar code printer customers a clear upgrade path to RFID technology.

On Monday, we announced the availability of the industry's first XML embedded, enabled RFID printer/encoder, which can reduce integration, complexity and total cost of ownership with next generation ERP warehouse management and supply chain logistics software. With these offerings, Zebra has the broadest line of RFID printer/encoders available now to meet RFID initiatives. Additional products are scheduled for release later this year.

In addition to product expansion, we continue to increase the number of RFID certified bars. We also added applications and field support specialists, and began developing dedicated international sales infrastructure for RFID. The expanded field force is working on another increasing number of pilot programs as Wal-Mart, vendors, and others are preparing for the launch of RFID in the supply chain beginning next year. As I mentioned in my opening remarks, these early results are encouraging. From the pilots we are involved in, we have seen [inaudible] rate improve dramatically from unacceptable levels earlier this year, to nearly 100% today. The pilots are doing their intended job; proving the technology in a real world environment.

In June, Zebra was pleased to host a meeting, in which consensus was reached on the next generation UHF EPC standards. From this consensus, the process of writing the technical specifications can begin. The specifications are currently scheduled for release in the October time frame. While precise time for full scale rollouts will remain uncertain,these milestones will enable the more rapid adoption of RFID technology. And indeed, the agreement on a standard is very, very encouraging and a very, very significant development in the industry.

A few comments on the first half of 2004. Our performance we achieved in the first half is a result of our ongoing commitments to invest in areas targeted at extending Zebra's global leadership. You are aware of the success of our geographic expansion program, backed by an innovative stream of new products, and a greater solutions approach to our business. Results for the first half of this year also include expenditures in areas that offer substantial incremental growth opportunities, and high investment returns. These investments include expansion in China, Mexico, and other high growth international regions, radio frequency identification, card imaging, and vertical market applications.

We recently decided to take advantage of our excellent first half results, and increase investments in strategic areas to support further growth, next year and beyond. We've already approved increased budgets for product development in card imaging. Increased investments are also expected to accelerate geographic expansion. Because we believe in the long term future of RFID, we'll be increasing our investments to solidify our leadership role in printing and encoding.

In addition to our financial strength, we're able to undertake these expenditures because of our outlook for further growth and continuing high levels of profitability. The future for zebra is bright, indeed. Our business is performing well, we're operating in a favorable environment for the adoption of AIDC technology, with a highly effective global business strategy. Our forecast for the third quarter indicates continuing strength over the near term.

All of these activities we discussed today, give us great optimism for the long term, and further creation of shareholder value. We thank you very much for your interest in Zebra, and we'd be very happy to answer your questions. Thank you.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1, on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Jeff Rosenberg with William Blair.

Good morning, how are you? A couple questions. One, I'm thinking about the strength in North America, and one of the things I've been hearing about has been some significant activity relating to the XML opportunities, I don't know if I fully appreciate that. I want to know if maybe you could add some color, not necessarily related to RFID, but more broadly as to what you're doing in that area, and your perspective as to whether or not that is a pretty significant opportunity in the enterprise.

There's a number of people that, I think you may know, Jeff, that we introduced an XML product earlier, I think it was earlier this year. It could have been late last year. And that was not an RFID enabled product. And, we've gotten some favorable reaction from that product from people who are Oracle users, SAP users, and consequently decided to extend that capability into the RFID product line. I'm sure you can tell by all the announcements that I recapped today, which are really just recent releases, we're very serious about the RFID segment, and we want customers in all regions and utilizing all different types of IT technology to be able to easily implement our products, and the XML is just a continuation of that approach to the market.

But generally, as you look at XML? Do these opportunities tend to be larger and should we think of this as being --

They tend to be enterprise solutions, large enterprise solutions.

Okay. Thanks. And then Randy, did you give operating expense guidance, or just generally, what kind of operating expense increases should we be thinking about relative to the investments that Ed was articulating.

Well, the numbers I gave you, I think, were 41 to $43 million and include the increases in some of the areas that Ed mentioned. Now, there are other things that we're looking at, as Ed also mentioned, for additional incremental investments. But the range that we gave, covers any likely increase that we would anticipate in the third quarter. Going into the fourth quarter, we'll talk about that in October. But, the 41 to 43 is what we're guiding to.

And the exit cost portion of that?

$876,000.

Okay. Great.

In the quarter.

Thanks a lot.

That was in the 2nd quarter. It will be roughly the same --

-- we talked about what it would be --

Okay. It's $475,000 of exit costs in the third quarter. It was 876 in the second. The exit costs are coming down.

Okay. Sorry, if you had given that out already. Thanks a lot.

Your next question comes from Chris Quilty with Raymond James.

Gentlemen, great numbers. Questions for you. Can you expand a little bit on the mobile printing business where you've seen good strength for the last several quarters, is that coming out of a particular vertical market, and also is there strength geographically in any place, relative to the United States, where you're seeing stronger growth?

The -- historically you found mobile printing devices used actively in the retail sector. And within the retail sector, applications such as shelf labeling, price markdowns, shoe busting, line busting applications, were some of the popular applications for the technology.

Any significant growth outside of the retail.

Yes. Yeah, basically, in the area of warehouse distribution, and even in the general factory environment. The utilization of mobile technology is taking hold. You know, because people working in the warehouse areas can move around with the mobile printers, and use them for a variety of functions. You have situations, where you're doing put-aways and -- or breakdowns, and so it's a -- it's convenient to be able to produce another label while you're up on a forklift truck.

In the shipping dock area, you've got a high activity area, so rather than having a stationary printer, you know in the center of that area, and people bumping into each other and having goods moving around, people are able to carry printers with them, And apply the necessary labels to the products. Not go back to a fixed location for the products.

Okay. And when you acquired that business, I remember your comments at the time, were that it had better consumeable retention than the regular printer business, the desktop printing, does that still hold true?

Yes, it does.

And just as an overall category, if you looked over the last 3 years, is it fair to assume that mobile printing has continued to increase as a percentage of overall printer sales?

You could assume that.

Can you give us a ballpark of what the increase has been?

No ballpark's today.

Okay. I won't even ask the question about --

-- time at Wrigley Field anyway.

I won't even ask the question about the ID card printer business's growth then. All right. Thanks, guys.

Your next question comes from Peter Barry with Bear Stearns.

Hi, gentlemen.

Hi, Peter.

Ed, I'm going to try a fool's rush in right after that question, and ask you, could you put some more color on the card imaging and mobile wireless investments that you plan on making for the remainder of the year. You detailed RFID and global expansion pretty well. Could you give us a few more thoughts on the other -- those 2 areas.

You know, I'm not going to speak to particular products or particular markets, because I just have too many competitors who are interested in that kind of information. So, I can't comment from that perspective, but what I would tell you is that the breadth of our product offerings will increase. And the markets that we're able to go ahead and penetrate will be enabled by having that greater breadth of product. And I could tell you that that is a -- those were global initiatives.

We're seeing the -- we're starting to see the adoption of this technology in places, in many places outside the United States. We did start up about 3 years ago or so, in Europe, and we've now penetrated a variety of places and -- you know, so we have a brisk market there. Moving down into other regions is now an opportunity for us, and, you know, I might add that in the recent AIT contract, that was awarded, there are -- there are mobile printers that are in that package of products that have been bid.

Is homeland security, the Department of Homeland Security becoming more significant, a potential if not real customer for you.

I don't have that data. I really don't. I really don't know. The question comes up a lot relative to the utilization of photo ID cards. And certainly there is increased activity in that aspect of homeland security. However, I think there's a few analysts that are on this call, that are tracking companies that are offering products into those segments, and the business has been slow to come in many areas, even though the applications seem to exist.

Randy, would you happen to have a calculation of return on invested capital excluding the $500 million in cash on your balance sheet?

Yeah, actually, I think I probably do have that in here.

And maybe if you could give us a year-to-year comparison, as well?

You're really pulling at me here, guy.

If I only get one question, I have to make it a long one.

You're exceeding your limit, but -- you.

have that reputation for the world's longest question.

That's the only reputation --

What I got is 51 -- how would you like 51.3%.

What is that compared to, that's amazing --

From a year ago, it was only 43%, gosh. You know, we're -- it was a -- at 51.3% is what it was this quarter.

Now I'll ask my follow-up. Ed --

You mean you didn't do that already?

You mentioned vertical market applications as another target for renewed investment. Are there new -- other verticals or are you referring to Life Sciences as the new vertical?

Well, Life Sciences is a vertical that we have put resources into, and we'll put more resources into actually. But there are -- there's a variety of different verticals. I mean, I will name one other, and that is the citations, the police citations for traffic violations, for moving violations. The utilization of the technology by the police departments is a growing area. And in that -- in those particular applications, it's both PDA's as well as printers that are employed. So you find us in many cases, in all cases, I'd say, collaborating with PDA providers in order to ultimately provide a solution for that application. And so that's a really useful and in some cases, the printers don't leave the vehicle, and in other cases they are -- they can be hand held, like someone walking up the street issuing parking citations.

Thank you both.

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

Good morning. Ed, you've talked a lot about international expansion. I want to see if we can get an update from the standpoint of -- you've been adding infrastructure for the better part of a year, year and a half or something like that, maybe even longer.

Longer, yes, sir.

What other adds would you be expecting in terms of, you know, number of people or number of geographies, and can you talk about the traction that you've made with the adds that you've made already?

You know, a key area in terms of global expansion for us, and no big secret for most every global company is in China. And, of course, Hong Kong which is part of the greater China, as well as Taiwan. Those are important areas for us. And they -- so we have expanded office, we've expanded head count in each office, and we've gone beyond, you know, just providing feet on the streets so to speak, providing other areas of infrastructure to make us more successful in those regions. We -- I think we enumerated here in the call, Mexico is a growing, important area. Everybody's quite well aware of the Mikeeladores (ph) that are set up along the border between the United States and Mexico. There's lots of business enterprise in that area.

You've got also areas in Europe, particularly eastern Europe that have evolved. And those are, since the collapse of the former Soviet Union, the whole layout and opportunities that have changed in that region of the world. So it's a big world, and we like any company, we have a limited amount of resource and it takes a certain amount of time to roll things out. But our global initiatives are -- you know, are pretty large. I think Randy noted in his presentation, I think 46%, in that range, 46% of our business is directly outside the United States. Some of the business that is counted as U.S. business is really shipped within the U.S., but then it's trans-shipped outside the United States. So there's a good chance that maybe half of our business today, is consumed outside the United States. It's really a global enterprising market into maybe 80 countries around the world.

And just given those initiatives that are underway, do you have a sense for what the relative growth rate over the next couple of years might be in those international markets, versus say, the North America market which is presumably more penetrated?

Yeah, well, while we would -- I would generally answer the question that our expectation is higher growth outside the United States than within the United States, I believe this -- just looking at the numbers here, for this particular quarter, the -- let's see what that number was. Randy had it in his presentation.

Growth -- here it is, inside the -- North American growth was 25.8% overall. Outside the U.S. is 24.9. It was slightly higher in North America.

Almost equal, and the percentage of business in those 2 packs are not quite equal. 46% versus 54%. So that's how it's splitting out. I would expect -- I would still expect more growth outside the United States, than inside the United States. That has been the long-term trend. And I just look at the investments that we're making and what's going on in those particular regions, and it should continue for some time.

One last quick question. The industrial markets, is the resellers and other companies that have reported, talked about, haven't yet seemed to have been that strong.

The industrial markets in the United States have improved markedly, in particularly the last quarter.

Is that something that you would expect to continue, though, as those markets lag and they have a couple quarters of pretty good growth?

I don't know. I really don't know that. It gets into a whole bunch, many factors that it's hard for me to personally evaluate. But I can tell you that the -- I think I just saw -- I think it was this morning, I saw in terms of large appliances, durable goods, manufacturing in the United States, consumption picked up markedly in this last quarter.

Thank you very much.

Yeah.

Your next question comes from Mark Roberts with Wachovia Securities.

Thank you, good morning. I actually have more than 2 questions, so I'm either going to have to ask a really tortured multi-part question and a follow-up, or you're going to have to let me ask 3 questions.

Or we'll have to ask you to call back later. Okay. Go ahead.

All right. Ed, a number of companies in your strategic position have started to pay out a dividend. Is that something that you all have contemplated and/or are contemplating?

We've considered it. We are not contemplating it.

Okay. My second question to you, Ed, you're talking about -- you mentioned that --

I think we just declared a dividend. I think everybody's getting an extra share of stock for every 2 they have.

Okay. But in terms of cash dividend, it's not something you're contemplate?

No.

Okay. And you mentioned that a number of the pilot trials are starting to see read rates on tags, get up to approaching 100%, which is kind of the Wal-Mart and DOD standard. Can you talk a little bit about the technology that's enabling that? Is there a specific tag design or tag technology? Is it the reader technology or is it, you know, suppliers becoming smarter and how to pack pallets, that sort of thing.

I suspect -- well, first of all, most of the testing that has gone on, if not all, let's just say most, is at the carton level, not at the pallet level. So in terms of read rates that we're talking about, we are not -- I'm not commenting at 100% read rates for fully stacked pallets. That is a whole other story and that's not where pilot testing is going on by and large today. It's not even the -- Wal-Mart's requirements to conform with that on January 1. But in terms of all those things that you listed having an impact on the quality of read rates, I don't have any kind of a breakdown that I personally could give you. There's probably some people around here that know what are the key factors. But probably all those things you mentioned have some level of contribution.

People have been coming at this from a lot of perspectives, because this technology is close to worthless unless the read rates are very, very, very high. And you just can't have false reads, or no reads, in the RFID area, or you're just not getting the -- you're not getting the real benefits that RFID is capable of delivering, in terms of useful data for people to act upon. So there's lots of pressure in that regard to make that happen. And the reading devices and the antenna systems that are used, certainly are critical components in those solutions.

Okay. So in the context of Symbol yesterday announcing the acquisition of Matrix.

Yes.

We're not going to get you to sort of comment on the quality of the relative tags that are being used in the pilot trials?

No, you're not going to get me to, but not because -- for multiple reasons, one of which I couldn't actually tell you.

Okay.

There are so many different pilots going on, which so many different companies in so many different locations that give -- that have a total oversight on what's happening is -- I certainly don't. So no answer there.

And my last question to Randy. Randy, in crunching through the numbers here, I'm coming up with results that would indicate that your guidance for the third quarter -- I mean, if you look at the second quarter results, it would indicate to me, that kind of, an almost worst case scenario, would you hit the very high end of your guidance range for the third quarter.

So, you're very optimistic?

Well, I'm just -- I'm sort of looking at the mathematics here. Are there specific things in the third quarter, either in terms of margin, or in terms of overhead spending, either R&D or SG&A, that you're aware of, that we should be factoring into our models or are you --

I'll give you one piece of that. And it's -- actually an important piece. And the typical situation for us, is to find our business weakening, third quarter versus second quarter, in the European area. So that represents about 30% of our business, so 30% of our business will very likely go down sequentially second to third quarter. In order to go ahead and have an increasing second to third quarter, really means that we have pretty impressive growth, has to take place in the rest of the world, the other 70%. That is the main reasoning behind the kind of projections that we make for the quarter. With that said, it doesn't always work that the growth is modest between the second and third quarter. However, if we go back in time, and look at lots and lots of quarters, we have many time periods where there was no growth between the second and third quarter, between the third and second quarters, I guess I should say. So that is a contributor to the guidance that we provided you.

Okay. Thank you very much.

Sure.

Your next question comes from Kevin Starke with Imperial Capital.

Two questions, really. What's the extra CapEx being spent on?

I'm sorry your question?

What are you spending the extra CapEx on?

Well, this -- the extra CapEx is going into product development projects, tooling, we're doing some expansion of a -- our facility in Camarillo, and we also have IT investments that we're continuing to make.

Second question, the Paxar suit appears to have been stayed, pending some administrative process, can you tell us what's going on there?

We'd rather not comment on litigation that's going on. I mean, I will tell you that we are spending, as we indicated in administration expenses, a component of that increase -- increased legal fees, from a variety of areas, one of which is ongoing litigation. We're spending increased amounts of dollars relating to intellectual property, and supporting our international expansion, we're spending money on opening legal entities in various parts of the world. So there's a whole variety of reasons why legal expenses were up. And one of the components is, of course, the Paxar litigation.

Your next question comes from Ajit Pai with Thomas Weisel.

Good morning, gentlemen, and congratulations on a great quarter. A couple quick questions. The first is going back to the competitive environment and the fact that Symbol announced it was going to acquire Matrix yesterday. That's a sort of complimentary product of yours in the IDC, combining with a vendor of yours. How do you think that would affect competitive dynamics and could they potentially become a competitor of yours?

You said combined with a vendor of ours?

Matrix does provide you with some supplies in tags, and you do sort of work with Matrix on providing their tag, right? The engines for --

We work with Matrix.

Yeah.

So the question now is?

Is it potentially [inaudible] in Matrix? It could change the competitive dynamics in terms of ppotentially becoming a competitor?

I guess they could. They haven't told us that Your question is, could they become a competitor.

Right. Does it change anything in your relationship with Matrix, if they do get acquired by Symbol?

I'm not aware of any change in our relationship with Symbol. As a matter of fact, I would say this transaction is more likely to improve relationships with Symbol, than it is to hurt relationships. I think we would have more things to be working with them.

Okay. And the second question is related to sort of your FDA bar code opportunity. Could you give us some color as to what kind of traction you're getting over there, and whether that's an opportunity that you see taking off this year or later next year.

I can't give you real specifics on the FDA initiative, but I can certainly tell you that the amount of activity that we have, relative to providing certain kinds of solutions that are enabled as a result of having bar codes on prescription drugs administered in hospitals, has a variety of companies interests in providing hospital solutions has increased, and we're working with those companies.

And just one follow-up on that. Could you give us some color on the direct versus indirect channel revenues in this quarter, and how it compares with sequentially and year-over-year.

No. We couldn't.

Okay. Thank you so much.

Your next question comes from Brian Dishwalley with Piper Jaffray.

Good morning, guys. Just a quick question here, follow up on the RFID scene. I was wondering if you could give a little more detail or information surrounding the general movement or adoption, in the pace of some of the pilot initiatives, how they've kind of ramped up. Also maybe give us a little flavor for which products seem to be hitting the demand curve at the right time now, and maybe a little bit in terms of your incremental investment and what that will do to some future product launches here over the next 6 to 12 months.

Which one of these questions would you like me to answer.

All of the above.

No thank you. Which one would you like to have answered?

I will take the size -- just the general ramp of the market question.

The activity level relative to pilots is clearly increasing. I think that there are companies who realize, or who realize more so than perhaps earlier, the seriousness of Wal-Mart in terms of implementation in a timely fashion. And so consequently, there's some companies who, perhaps were sitting on the sidelines who decided that it's time to get off the sidelines, and find a solution to their problems. So that's what I would say. I'm seeing in terms of the actual sales or placements of hardware, it's going up very fast. But it's going up very fast from a very small base, and by and large, companies are not placing large quantity volume orders for these products, because they're still in the testing stages and haven't made the determination -- the decisions to roll these out, excuse me.

Great. Thanks a lot. One follow-up question for Randy, perhaps. Randy, on the expense side of things are you seeing any impact -- if so, maybe quantify that a little bit.

Yeah. We are, definitely, we're seeing impact on it. We've got more of our resources are dedicated specifically to these compliance efforts. We had to increase our staffing and our internal audit area. I would say, my recollection is, we spend probably incrementally about half a million dollars overall on quote, unquote, Sarbanes compliance effort. Some of that is not all incremental. A lot of that is redirecting activity of people we already had in the organization. But some of its incremental.

great. Thanks a lot. Nice job today, guys.

Thank you.

Your next question is a follow-up from Mark Roberts with Wachovia Securities.

Thank you. One more question without a follow-up. Can you give us any, 10% or more customers in the quarter, and specifically, can you give us what ScanSource was --

Well, ScanSource was the 10% customer, and ScanSource is 14% of quarterly sales.

And that's your only 10% customer?

Yes, that's correct.

Great. Thank you.

Your next question is a follow-up from Greg Halter with LJR.

I didn't know I asked a question yet.

But you only get one follow-up.

Follow-up to the one I didn't have. Couple days ago, I read a comment from one of the competitors about price pressure on the entry level printers. Can you comment on what you're seeing there, and what that level may be, if you're seeing it.

In what category is this?

I would presume it's entry level printers.

What kind of printers? We have a -- we're in 4 different product categories, do you know what this is about?

I do not. But I would presume it would be card printers.

Card?

Yes.

Okay. So someone said there was pressure at the low end of the marketplace?

Correct.

Well, I don't know who made the remark and I don't know exactly what that was, but what I would say is that, we announced a product, just this last week, and I think it's our model P205. And the P205 is a low end product, I think it's either 15.95 or 16.95 as the price on that product. And it's one of these products that's a very small footprint product, that you can insert cards one at a time, from the front of the machine, and it comes back out to you. So it's a lower volume application. It's the lowest price product we have in the market.

Perhaps whoever said that, saw that press release, and viewed that as pressure the at the low end. We do have other products, we have a P210 which is somewhat more expensive than the 205. And then there's 300 series products, that come after that. So we're -- our product line is quite strong toward the low end of that range. Now keep in mind that we participate in utilizing predominantly dida (ph) fusion technology, and certain band width in terms of types of product. So that's -- that may be -- I'm just guessing what the source of the remark was -- that gives you a primer on the low end of our card printer product range.

Okay, great, thank you. And one quick one for Randy. Any change from the portfolio composition in the quarter?

This is an easy one, no.

Thank you.

Your welcome. I think at this point, with all respect to your time, and the pressure of earnings season, we're going to stop answering questions at this point. If anybody has any follow-up questions they'd like to call us directly on, we'd be more than happy to take your calls one on one. So with that, I think we're going to close out the conference call.

The only additional piece of information I want to provide to you, is that we will be having our third quarter conference call on October 27th, 10:00 central time. And hope you'll all be attending for another quarter of great Zebra financial results. Thanks for your attendance today.

Thank you for participating in today's conference call. You may now disconnect.