斑馬技術公司 (ZBRA) 2008 Q2 法說會逐字稿

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

All lines will be in listen-only mode until after today's presentation. Instructions will be given at the time in order to ask a question. At the ask the Zebra Technologies this call is being recorded. Should anyone have any objections please disconnect at this time. At this time I would like to introduce Mr. Douglas Fox of Zebra Technologies. Sir, you may begin.

Thank you and good morning. Thank you for joining us today. Certain statements we will make on this call will relate to future events or circumstances and therefore will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, and anticipate are a few examples of words identifying a forward-looking statement. Forward-looking information is subject to various risks and uncertainties which could significantly affect expected results. Risk factors were noted in the news release we issued this morning and are also described in Zebra's 10-K for the year ended December 31st, 2007, which is on file with the SEC. Now, let me turn the call over to Anders Gustafsson for some brief opening remarks.

Thanks, Doug. Good morning, everyone. Thank you for joining us. In addition to Doug we have with us today Mike Smiley our new CFO and Mike Terzich, Senior Vice President for Global Sales and Marketing for our Specialty Printing Group.

Today Zebra reported record sales and strong operating results for the second quarter. We also announced a more cautious outlook for Q3. Our solid performance across the company was driven by our programs to diversify our customer base, expend Zebra's geographic footprint and introduce new products to meet more customer needs. The addition of new channel partners, vertical market expansion and more resources in our international regions benefited our Specialty Printing Group. A strong sequential sales increase put us at the top end of our forecasted range for the Enterprise Solutions Group as a result of improving traction (inaudible) the recently introduced products and continued deployments of terminal operating systems. Gross margin exceeded 50% for the first time since the fourth quarter of 2005.

During the quarter we made progress on our strategic initiatives to accelerate sales growth and increase profitability. First, the continued integration of the WhereNet, proveo, Navis and MSSI into one division, ESG, has strengthened the organizations infrastructure to support and manage the business as well as how best to apply the breadth of our technologies to meet more customer needs. Second, our global supply chain transformation is well underway. And third, a number of new product introductions have helped us win additional business with new customers in attractive growth verticals.

Let me now cover some of the highlight in our second quarter results. In our Specialty Printing Group, record international sales and nearly 10% growth in North America enabled us to deliver the second consecutive quarter of double-digit growth. It was the business units fifth consecutive quarterly sales increase. The growth was broad based with several printer lines posting new sales records. Increased resources to focus on channel development and vertical market applications resulted in another record quarter for Latin America. During the quarter we secured significant new wins in manufacturing and government. Stronger Latin American economies are creating additional opportunities in manufacturing, which compliments our strong position in retail and mobile workforce applications.

In China our strategy to penetrate new vertical markets and expand our presence in additional major cities continued to generate results. In Asia-Pacific, record sales resulted from key wins in manufacturing, retail and government. The launch of our Partner First Channel Program for the region gained traction with the recruitment of additional new channel partners. We anticipate further growth in this region, which holds significant long-term opportunities for Zebra.

The second quarter saw a sharp rebound in our SPG North America business. The region benefited from continued strong growth through the channel aided by the success of our diversification efforts and vertical market expansion. During the quarter we secured business with new retail customers, including some with kiosk printers. A definite growth area for the company.

Other highlights of the quarter include important wins in direct store delivery, hospitality and government. These successes offset weaker sales to key accounts in retail and small package delivery.

The rapidly changing economic environment in Western Europe caused SPG to fall short of its targets for the first time in nearly three years. A slowdown in Italy and the UK with notable weakness in the retail offset strength in France, the Nordics, Germany and Eastern Europe.

Let me spend a moment on Zebra Enterprise Solutions Group. With a period of solid bookings, ESG had good revenue flow from air time licenses and services. During the quarter we announced new terminal operating system wins in Vietnam, Canada, Latin American, and the Middle East. I am particularly pleased that Navis is tracking ahead of expectations with several go-live dates for our new platform, the SPARCS N4 Terminal Operating System, planned for the remainder of this year.

Business interest and opportunities for proveo are also on track with implementations of new systems to manage airport ground support equipment. Building on the ESG integration in the first quarter we consolidated strategy and product management with service and support into a single organization and we are in the process of integrating the MSSI and WhereNet hardware groups. We also began implementing the common supply chain and are now in the early stages of developing a channel strategy for 2009 as well as focusing on migrating solutions across verticals. All of this work has led to improved visibility in this new business unit. In addition to finding new opportunities for growth, we are taking corrective action as needed to address issues we have uncovered in the integration process.

In the first half of this year we took remedial actions to improve WhereNet product performance issues in the marine terminal markets. This is an important part of our overall plan to maximize the value of our investment in WhereNet in ESG.

We also introduced a new material flow solution to enable manufacturers to better manage their replenishment operations. Based on WhereNet technology material flow was an important contributor to second quarter ESG sales and it has a growing pipeline which gives us confidence for further growth in the second half year. Material flow helps manufacturers decrease labor costs, lower inventory levels and eliminate underutilized assets which is a key area of scrutiny by manufacturers. All while delivering a hard and rapid [online]. Our ESG team is working hard to bring the WhereNet solution to the level of performance required by our customers. I am satisfied that we are moving in the right direction and that our ESG investment will deliver the value we expect for our investors.

Overall, I am pleased with how our total business is performing. Clearly, Zebra continues to extend its global leadership in helping customers identify, track and manage valued assets, transactions and people across the supply change and within the enterprise. We continue to increase the value content of our solutions with a greater set of identification technologies and applications software. We enter the second half of the year more cautious on the economy and the seasonal slowdown in Europe. But, we continue to have a great deal of confidence in our ability to execute on our long-term business plans and implement additional initiatives to support our growth objectives. Now I'll turn the call over to Mike to provide a detailed review of our second quarter results and guidance for the third quarter of 2008.

Thank you, Anders. Before we get to the numbers let me say I'm very pleased to be here at Zebra. I have already met some of you and look forward to meeting all of you in the near future.

This year we started breaking out results from the Enterprise Solutions Group and Specialty Printing Group. Results of each group reflect fully burdened numbers with depreciation and amortization and allocations of directly identifiable expenses provided by corporate -- provided by corporate related to those units. On an operating basis both business units contributed to strong sales growth. Record SPG sales included record international sales and the second highest quarterly sales for North America.

For ESG we had strong sequential sales growth. We maintained gross margins an operating expenses were within our forecasted range. Sales in the core SPG were up 12.8%. FX net of the $5 million loss in hedging activities in the quarter versus a $1 million loss in hedging a year ago contributed $5.6 million or 2.8 percentage points of growth. ESG contributed $25 million to second quarter sales. MSSI, which we acquired at the beginning of the second quarter had no material impact on the 16% sequential sales growth.

We burned off about $1 million in lost purchase accounting revenue in the quarter to leave about $4.8 million to deliver. The strength largely came from continued deployments of Terminal Operating Systems supplemented by growth in our new Material Flow-Replenishment product. The trajectory on these and other products make us optimistic for another sequential sales increase for ESG in the third quarter.

Let's take a look at sales by product line. Hardware sales were $185.6 million, up 17.3% over last year and representing 73.1% of total sales. All barcode printer product lines experienced growth with particularly strong growth in record sales of kiosk printers from the Swecoin acquisition in 2006. The percentage of printer sales from new printers held steady at 19% from the first quarter and up from 9.2% for the second quarter last year. We shipped 238,458 printers in the second quarter, a 5.3% increase. Average unit price of $630 was up 9.9% over a year ago driven by product mix, better pricing, and foreign exchange.

Record supply sales were $43.8 million up 8.7% and comprised 17.3% of total sales. The percentage of revenue from service and software continued to inch up. This category driven principally from the addition of Navis represented 10.8% of second quarter sales compared with 10.2% for the first quarter and 4.6% a year ago.

During the quarter Zebra incurred revenue hedging losses of $5 million. This loss had a $0.05 per share on earnings. We entered into these hedging contracts at an average spot rate of $1.36. The significant weakening of the dollar against the euro to an average settlement rate of $1.55 resulted in the loss. We entered into similar contracts for settlement in the third and to a lesser extend the fourth quarter.

Turning to regional sales breakdown. International sales were up 28%. Both Latin America and Asia-Pacific sales increased -- each increased better than 38% to record levels. EMEA increased 23.2% but fell short of our growth goals as Anders mentioned. Real growth in the region before FX and ESG acquisitions amounted to 5.4%.

Second quarter sales in North America were a record $112.3 million, an increase of 14.1% over last year. Consolidated gross profit reached 50.3% up from 47.6% a year ago. Gross profit includes some one-time items which netted a one percentage point contribution to quarterly margin. SPG gross margin increased to 50.5% from 47.9% because of the improved product mix and lower materials cost and FX impacts. Gross margin of 49.1% for ESG was up from 37.5% a year ago but down from 51% for the first quarter of this year on shifts in revenue mix.

Consolidated operating income increased 8.8% an delivered a GAAP operating margin of 14.6%. On a fully burdened basis, SPG operating operating margin was 26.1%, up 0.9 percentage points from a year ago. Direct operating expenses in SPG were up 20% from an unusually low level a year ago largely driven by costs for our First Global Partners conference this quarter, annual merit increases, and additional marketing expense. Results for SPG also included $4.7 million in exit costs for the outsourcing initiative which lowered EPS by $0.05 per share.

The bulk of Zebra's operating expenses increase relates to the Navis acquisition. ESG expenses also include an incremental $1.7 million from the MSSI acquisition. Included in the ESG numbers is $4.5 million in intangibles amortization and stock options expense. For the third quarter we are expecting a significant reduction in operating loss for ESG. On a consolidated basis we expect a reduction in the spend rate for the third quarter with the elimination of expenditures for the SPG Global Partners conference, Navis World Customer conference, and other one-time items.

Expenses for 123 totalled $3.1 million versus $3.2 million last year. Investment income totalled $2.7 million. Diluted earnings per share came in at $0.39 per share on 65.5 million average shares. The sequential increase in accounts receivable was due to higher business activity. Inventories are up more than expected from additional stockings related to our outsourcing initiative. The building up of parts in advance of the launch of new product introductions and some increases related to differences in actual sales mix of the anticipated mix. We are monitoring inventory levels closely. Capital expenditures totalled $114.3 million for the quarter, principally from the expenditures on our ERP implementation, which is on schedule and within budget. We ended the quarter with $270.1 million in cash and investments.

During the quarter we purchased 461,000 shares of common stock. Year to date we have acquired about half of the shares under our three million share authorization with a deployment of $48.4 million.

Our guidance for the third quarter indicates sales growth of 11% to 16% to $242 million to $253 million. With SPG sales of $218 million to $225 million and ESG sales of $24 million to $28 million. This forecast takes into account the usual summer slow down EMEA and expected $500 million loss in hedging activities and the relates of stiffer economic headwinds going into the second half of the year. Earnings are expected in the range of $0.34 to $0.41 per share. Our forecast assumes gross profit margin in the range of 48.5% to 50% and GAAP operating expenses of $86 million to $88.5 million, a reduction from the second quarters $90.7 million. We are estimating outsourcing costs in the range of $3.2 million to $3.7 million. That concludes my formal remarks and thank you for your attention. Here is Anders for concluding comments.

Thanks, Mike. Zebra performed well in the first half of 2008. Sales were up 20% with strong organic growth in our Specialty Printing Group and increased momentum in our six-month old Enterprise Solutions Group. We maintained high gross profit margins and continued to control our direct operating expenses.

Operationally we made progress on those activities that will enable us to achieve our vision of providing solutions to customers to help them identify, track and manage assets and transactions and people. The success of our global expansion activities is evident. We are also -- we've also made significant progress in our virtual market penetration with greater diversity in our customer base. Furthermore, we made progress in our goal to develop greater customer intimacy. We are now actively engaged with a large number of our top-end users in our targeting vertical markets. This high touch model has led to a growing pipeline and has already resulted in new key wins for mobile workforce and retail.

As a technology company we rely on the vibrant product portfolio to stimulate growth. The pace of new product introductions has increased. Most recently we announced two important new printer products. The G-Series, next generation of desktop printers and the HC100 Dedicated Wristband Printer. We also added to our accessories offerings for route accounting and direct store delivery solutions; along with a new infant wristband and other labeling supplies.

Our invasion and leadership in printer products recently led to the largest RFID deal, which we are aware of to date. Approximately 250 Zebra R4i UHF RFID card printers will be deployed to print and encode season ski passes at Vail Resorts in Colorado this coming winter. The R4i is the only UHF card printer available in volume. It will be paired with RFID cards incorporating a Zebra design inlay. This project opens new opportunities for growth. Both the product in our core Specialty Printing business and in our Enterprise Solutions Group.

Going forward we will continue to invest in developing the solutions and channels that will extend our leadership and secure long-term success. At the same time we will continue to aggressively manage operating expenses through more challenging economic environment. As we have told investors many times, while Zebra is not immune from economic fluctuations we are positioned better than many companies to sustain growth and profitability. Thank you for listening. We are now happy to take your questions.

Thank you. We will now conduct a question and answer session. (OPERATOR INSTRUCTIONS) All analysts are allowed one initial question and one follow-up question. One moment while we poll for questions.

Our first question comes from Reik Read with Robert W. Baird and Company. Please proceed with your question.

Good morning. Can you guys talk a little bit about internationally -- maybe two things. One, you gave some good detail in terms of the individual countries and how those did but can you talk a little bit about how the environment might be changing? And then, two, Anders, in your comments with Latin America and to a certain extent with Asia you were saying some of the resource deployment helped drive some of the strength there. I wouldn't look at channel resource deployment helping initially so I'm assuming that what you're talking about is some investments that you've made in the past. But are there some things you've done in the last quarter or so to really start to accelerate that? Thanks.

So, first on the overall environment that we have seen internationally. The slow down we saw in Europe was quite specific to the UK and Italy and particularly exposed to retail. We saw there -- I think a general slow down in the economy. The outlook for those countries are a bit more muted for the second half. But we saw good growth in many other parts of the region. Like I said, particularly eastern Europe and the Scandinavian countries.

The overall growth that was very strong for us in the emerging markets. So all the countries we have spoken about specifically about for growth, like the BRIC countries; Brazil, Russia, India, China and also eastern Europe and Turkey did very well for us. The investments I talked about were in the channels were really down beginning of this year and are starting to pay off for us now. We have started to also launch our Partner First Program in Asia, which has had good response from our partners there and we expect that to continue.

This is Mike Terzich. Let me just add one point to Anders' comments particularly in relation to your Latin America question. The investments that we have made in Latin America, a big portion of that investment was focused on really two regions. Mexico and Brazil. And those continue to be very strong contributors to our overall success in Latin America, particularly investments we made about 18 months ago up to about 12 months ago in Brazil. We have expanded our infrastructure, we have more resources, we have a legal entity, we have a new office, and that is paying dividends as we have recruited new partners, we have secured some new large pieces of business and we are very happy with what we are seeing out of that effort.

Okay. And then if I can just ask a follow-up on the ESG side of things. You mentioned you saw very good sequential strength from a revenue standpoint but gross margins down a little over 100 basis points. Can you talk about maybe some factors that might impact that and specifically could you comment on service revenue, software, the impact of the rebuild of the deferred revenue account and then any integration costs that might be a little high at this point?

So the makeshift was an increase proportion of services compared to Q1 into Q2 and also hardware. So that was really what accounted for the gross margin erosion. We are seeing opportunities for us to prune and tune the organization somewhat in order to make sure that we back off some investments where we don't see the same opportunities for growth but put those dollars to work where we do see the best opportunities. So we are rebalancing some of the investment within the group.

Great. Thanks much.

Our next question comes from Jeremy Grant with Stanford Group. Please proceed with your question.

Thanks. Good morning. I wanted to follow up a little bit more about the economy, specifically in your guidance talking about how you wanted to be particularly cautious given the economic situation. I think a lot of the message we've gotten to date has been that business has been holding up surprisingly well despite economic sluggishness around the world. I'm wondering outside what you're seeing in the UK and Italy if you are now starting to see a bit more of a slow down in other parts of the world relative to what you have seen in the first half of the year?

So I think the economic impact, economic headwinds that we are feeling has been really focused on Western Europe and North America. And when we talked to our channel partners they would say that if you compare this to say late 2007, at that point our end user, they they were growing, they had budget and they would fund and proceed with project -- investment projects very quickly. Today there is more scrutiny on projects. They tend to go through a much more rigorous return on investment calculation, which by the way really helps us in many ways. They also, though, see that projects tend to get maybe divided up into more phases so they don't release the entire phase in one go. But we haven't seen any cancellations of orders. Some push out but not cancellations.

But outside of Western Europe and the US, the only other precaution for Q3 is China where we expect that we will see some slow down due to the Olympics. They are slowing down factories around Beijing. Traffic in Beijing. So forth. We expect that to have some effect on our business in China in Q3.

Thanks. On the follow-up I wanted to ask a bit more about guidance for operating expenses going forward. Obviously they have been going up quite a bit the last year, both with the outsourcing initiative as well as integration of ESG. Realizing of course you only give guidance forward one quarter, I'm wondering if you can look a little bit beyond and talk about what sort of level you think these numbers are going to stabilize at?

First for Q3, we are looking to reduce OpEx quite substantially and even if you look at the head count for our core Zebra business and the corporate side we are basically flat on head count in the second quarter. We felt that the economic outlook was more uncertain and wanted to make sure we didn't get ahead of ourselves on recruiting. And I expect that we will continue to continue to be very frugal in our recruiting activities going forward, particularly in our core business but also in ESG to make sure we do only recruit the absolute necessary resources and in the right place.

Little uncomfortable to give you guidance on operating expenses for the longer term because it obviously depends somewhat on what happens with the economy in Q4 and Q1. We do value our profit margins and we are certainly working hard to improve them and we will deal with the OpEx situation based on what we see on the revenue side.

Okay, thank you.

Our next question comes from Jeff Rosenberg with William Blair. Please proceed with your question.

Hi. I wanted to ask a couple more on ESG. If we look at the reported operating lost. It looks like incrementally it is up about $5 million year-over-year. Should we think of that as -- how should we think of that as things getting tougher within WhereNet versus -- How should we think about the other profitability of the other businesses you acquired? I know you don't want to think of them as an integrated unit but just in general -- I know you are still in the process of integrating them. When you look at the newer businesses are they profitable or how far away are they from being where you would expect them to be in terms of reaching break even?

Yes. First, the largest acquisition we made to date is Navis. That is performing very well and making money for us. The MSSI acquisition is brand new and we still have some work to do before we make that profitable. We do expect to see, though a material improvement in our profitability of ESG in the third and fourth quarter of this year.

I guess if it is occurring in the third quarter it seems, though, it is not enough to really offset the overall decline in profitability which is obviously there is some negative leverage as you see sales decline in the core business. I guess can you give us some flavor for how material that can be in Q3 if given overall it is being more than offset by the negative effects of the weakness in the core business?

Yes. First maybe one more point on the year-over-year comparison. The amortization is obviously much, much bigger so the operating situation is not that much different. For Q3, though, we guided for between flat to plus $2.5 million of revenue for ESG and I think you can assume it will be a similar gross margin profile on that revenue stream as well.

Are you cutting back on expenses there, too?

We are cutting back some expenses in there also in the third quarter. We have actually already done so.

It is multi top-line growth that is driving this.

It that is more pruning an tuning to make sure we get the synergies that we have identified and we have the resources where we can believe can add the most value.

Got. One last question. When does the deferred revenue from Navis begin to come back to contributing? Is that a Q4 event? Can you give us a sense of what sort of profitability improvement that alone will give you?

Well, we had $2.3 million of revenue we didn't go through the P&L in the first quarter. $1 million in the second quarter. And I think we probably would have had expectation for more of it to actually flow through in the first half than we have seen. Our expectation this will probably roll off a little more slowly we have seen in the past and probably not really be completely used until 2009.

Okay. Thanks a lot.

Yes.

Our next question comes from Ajit Pai with Thomas Weisel. Please proceed with your question.

Good morning.

Good morning.

A couple of quick questions. The first one is back to ESG. I think you indicated earlier in the third quarter you expected to get to a break even in that business. So just based on the color you are provided now, if you exclude the impact of amortization do you think that you could get there with a drop-off in expenses or you thinks that unlikely given the change in the environment?

We have also added MSSI to ESG since then and our expectation is we will make a substantial improvement for profitability in the second, third quarter and gets close. I don't think we would say we will be profitable in the fourth quarter and we expect further improvement in the fourth quarter.

Got it. The second thing is just given the change in leadership on the finance side, the hedging policy that you have been following over the past couple of years could you give some color as to whether -- the manner in which you are thinking about it right now on a go-forward basis. The currency hedging?

I think that the approach before has been to basically hedge 50% to 80% of the euro revenues going forward and I think you saw in the press release the average spot rate -- a lot of the hedges we are seeing terminate or mature this year were bought last year. And so most of the hedging activities that you'll see mature for the rest year were likewise bought last year.

For 2009, obviously we will have a benefit for the full weakening of the dollar which isn't really reflected in our results. So, for example, the $5 million of hedging losses that we had in Q2 -- next year if we are at the same exchange rate that full benefit will flow through to roughly $0.05 a share in EPS. As far as what we do in 2009, I think we do want to make sure we manage our foreign exchange exposure and try to avoid the volatility that that can provide. But as far as explaining sort of what the program will be in 2009 and 2010, I don't think we want to talk about that right now.

Okay. But you do want to hedge it?

Yes.

Okay. Then the second is just looking at the cash on your balance sheet and acquisitions you have been making right now. Can you give us some color as to how you would prioritize the use of that cash right now especially the weakness in your stock and also the pipeline of acquisitions looks like right now for Zebra?

We have approximately the $50 million worth of shares this year. I think that's a material number for us particularly looking at that cash balance now that has gone down to below $300 million. We made one acquisition which was a relatively small one. I think the outlook for this year we are very cautious on acquisitions as we said before. We really want to bed down and get the value out of the acquisitions we've done in the ESG already. But there might be some small tuck in, particularly on the technology side, that would enable us to accelerate some new applications or new revenues. We are obviously -- still have $1.5 million of share buy back authorization and depending on the share price we will be active in the market.

Got it. When you are looking at your current tax rate. It has been fairly stable over a long period of time or in a range. As you shift your manufacturing strategy and some of the other growth that you are seeing in international markets what kind of tax rate, what kind of changes do you expect in that?

We expect the tax rate will come down somewhat. We are not quite ready to lay out the entire tax picture at this time.

Okay. Got it. Thank you.

Our next question comes from Chris Quilty from Raymond James. Please proceed with your question.

Good morning, gentlemen. Was pleased to see that the North American market showed a nice pop. I think it was 12% or so in your segment reporting. But I was wondering if you could perhaps give us an idea of a breakdown of the Specialty Printing Group where you saw most of the North American weakness last year, how much of that was related to SPG?

Chris, this is Mike. I'm not sure I understood the question. The last part of that question.

Okay, last -- before you did the -- acquired even WhereNet we saw weak numbers in the Specialty Printing business in North America. The number you reported today of 12% growth in North America includes both SPG and the Enterprise Solutions Group.

Right.

So if you took away the Enterprise Solutions Group is most of that jump due to ESG?

No, just the opposite actually. It is most of the North America growth is associated with the SPG business.

Okay. So that's a pretty dramatic lift from what you've seen in the last four or five quarters. What specifically would you attribute that to?

Well, there were a few things in the quarter. Our strategy as we've expanded upon over the last couple of years, vertical market expansion, and we saw some nice wins in some markets for us particularly two places. One was in direct store delivery space. This is a space that we entered about two years ago. It is a mobile driven solution space and what is going on with energy prices. We are seeing a lot of increased interest in companies that are looking to take costs out of their ability to deliver goods. A lot of these goods are kind of retail based. These are the guys that deliver sodas and bread and baked goods, et cetera.

Anders mentioned we had some success in the quarter with kiosks. So there is quite a bit of interest in self-help, unattended printing applications. So we saw some nice wins there. Then the broader success we had in Q2 was we had very good strength through the channel. What this means is this is typically driven by multiple markets but our channel business was very strong in the quarter and it was offset a little bit by some of the spot weakness in some of the larger lot retail business continues to be soft as you would imagine.

The actual growth for North America, the organic growth for our Specialty Printing Group was 9.2%.

Good. When you look at those two areas, the DSD and kiosk, do you think that the strength was primarily underlying growth in the market or competitive wins?

Well, I would say it is a little bit of both. I mean, the applications space has some opportunity in it, and clearly in a couple of those areas, the kiosk is a very fragmented market so I wouldn't necessarily say those were take share competitive wins but in the route space we are competing against some traditional incumbents and we are winning shares.

If I could circle back to the question that Ajit had asked earlier about the earlier prediction of Q3 break even in the ESG group. I put that note in my model but I'm thinking about it now. With that original prediction were you talking about an EBIT break even as you report in your 10-Q and your press release or was that factoring out the deferred revenues and amortization of intangibles and more of an EBIT -- an adjusted EBITDA number?

It was an adjusted EBITDA number. It was on a direct profit level. Again, remember we have added on MSSI since we said that.

Understand. So if you were to look at the $7.7 million loss, I think, that was in this quarter you would back out the $1.7 million of expenses from MSSI. I can't find my numbers here. $2.3 million of deferred revenue? And a couple million of amortization?

2.3 was in the first quarter.

It was $1.1 billion of deferred revenue in the second quarter.

And amortization of a couple million?

Yes. Amortization was $3.3 million in the quarter.

For ESG?

Yes.

Okay. So, yes, you are not all that far off from getting to the break even.

No.

All right.

We are making decent progress, I think. And we said we have good confidence we will be improving the financials for the top line Q3 and Q4.

Good. And finally, a specific update on how the outsourcing to Jebel is going?

We are satisfied with the outsourcing of our activities with Jebel. We have moved -- we now actually manufactured 100,000 printers in Jebel. Our annual run rate of 750,000 printers. So in the first half of this year we have done 100,000 printers and with the equivalent quality as we have had in our North America facilities or particularly in [Camoria], which is where these printers come from.

The overall program is running probably six to eight weeks behind based on us changing kind of the strategy of not moving tools but having to make new tools in China. But on the other hand, have been able to offset that delay with seeing greater than expected material cost savings. So the overall project (inaudible) -- the project [MPV value] is still very much intact.

Great. Thank you, gentlemen.

Our next question comes from Anthony Kure with Keybanc. Please proceed with your question.

Good morning. Just a quick question in the other item in the gross margin commentary. Sorry if I missed it. Wonder if you could give a little color on that?

You're talking about the one-time items?

Yes. The impacted gross margins or help gross margins by one percentage point.

We had two items that were affecting gross margins that went differ ways. The first was we had an adjustment to a we accrual. The we accrual is basically to take into consideration the costs to recycle products. That's an obligation we have within Europe. And we have had that program going on for about three years and we have examined that accrual and that -- we made an adjustment to that accrual.

The other thing is we had some adjustments to some lease expenses. So when you net that all out, those two items are basically a 1% improvement to gross margin.

Okay. Thank you. Then just a little more color on what's going on in Asia. Obviously the strong growth there. I'm just wondering if you could talk about the end products that are driving that. Are you getting more into the manufacturing base there and taking share from local competitors? Can you give us an idea what's going on there?

All right, Anthony, it is Mike. I will take that. Our business in Asia has been very good. It has been good for a number of periods now. And we saw growth predominantly out of two sub relations welcome relations within Asia. China has been very strong. And China has been and continues to be a core industrial manufacturing market for us. So we see lots of opportunity that have been created both by multinational manufacturers and local manufacturers. We are selling a lot of our big iron product in that region. Interestingly, China is also creating some opportunity on the mobile side as some of the per capita wealth is improving. Retail is beginning to become a much stronger market for us. So things in China look very good.

Other market that was strong in Asia in that region for us was Australia. And this has been a market that has really rapidly improved for us. And it has been basically on the heels of some strong retail opportunities that we've had in the region with some of the large Australian retailers across a pretty wide range of our product portfolio.

Okay. Great. Thank you. That's all I had.

Real growth in Asia-Pac was 24.3% for the quarter.

You have a follow-up question from Reik Read from Robert W. Baird. Please proceed with your question.

I just wanted to follow-up on the ESG side of things. Anders, I think in your comment you mentioned you had to retool some WhereNet products for the marine area. Is that something that added some incremental costs and now those costs are going to come out and that also helps the transition that you're talking about?

No real incremental costs. They are already in our P&L largely. So I don't expect that they will come out based on that. But we have been working on that for basically the last six months to improve the performance of the solution in marine terminals. And that should open up more opportunities for us elsewhere as we get the performance to be that much higher.

I guess I'm asking, is the bulk of that done, and so therefore --

The bulk of that is done. We still have some work to do but we expect by the end of the third quarter we should be largely done with that.

I wanted to follow-up. Maybe I didn't understand this. It sounds like you're saying from a mix perspective software will kick in a little bit more as deferred revenue kind of kicks back in? For the third quarter? I'm just trying to understand the incremental difference.

I don't think we said that for the third quarter particularly. I think in the third quarter we would expect the mix to be similar. We had deferred revenue in Q2 but we will also have deferred revenue in Q3.

We expect to be similar from quarter-to-quarter .

Okay, great. And just one other question if I could. You guys have seen pretty good quarterly improvement really over the last in your ASPs. Can you talk a little bit about what's behind that and are you seeing some component inflation that's eating that away at that, or not?

Reik, this is Mike. I'll talk about the ASP portion of that. We have right, absolutely. That's a good observation. We have been very focused on our pricing strategy and we've made a couple of changes across the globe that have helped that. Primarily we get some discipline, good discipline as we roll out Partners First across the regions. We get -- we tend to get better pricing discipline with our channel partners and that has improved our situation there. And particularly over the last couple of years in our Asian market, which has been more price sensitive, we put some more administrative controls in place on some of the special pricing opportunities that we have seen. And then you are getting, as you know, you're getting some foreign exchange benefit that is driving up the ASP.

So net-net we are on a very nice trend over the last few periods relative to average unit price. The other piece that you're mentioning, as we have seen some cost increases on the side of the business with oil being what it is, we are seeing some increases from our suppliers on the label and the ribbon side of our business and like everyone else we've passed those cost increases on to our customer base.

And, Mike, the disciplines that you're talking about with respect to ASPs it seems like you're kind of lapping that. Is that something where you really don't see a whole lot of additional improvement, it just becomes stable? Is that the right way to look at that?

It may very well be. I think its run its course for us. I think it's been good. I think as we introduce new products that helps potentially. It offers some other opportunities for us. But I think it is okay.

Okay. Great. Thanks a lot.

Our next question comes from Marc Heilweil from Spectrum Advisory Services. Please proceed with your question.

Anders, let me have a chance to ask you a broader question. Zebra before the last down turn has shown a steady, if not a very sharp slope, decline in its profit margins and its profitability certainly from the '90s and maybe I guess at the beginning of this century. What is your view of, reasonable view of what kind of profitability, profit margins and perhaps return on assets this company can realize -- smoothed out over a cycle?

First of all, we do expect that we will be able to generate good revenue growth over the next three, four years. Both from core business and also from ESG and that should give us some scale to improve our margins. We also have some substantial -- significant programs in place to reduce our cost structure. First and foremost our outsourcing program which we said we expect to get a cost savings of between $25 million to $30 million by 2010. We also have an EOP program which should enable us to drive more synergies and OpEx improvements. And the third, when we get three years out or so we mentioned that we expect to have cash earnings. Cash EBITDA number, 22% to 25%.

What do you think accounts for the decline in the profitability of this corporation over the last six or seven years?

That's a long time. If you go back to 2004 maybe because that's when I think our margins kind of peaked. That was a year when we had some very, very large orders from a large retail customer of ours and we grew revenue a lot faster than we could grow OpEx and since we have had to try to diversify the business a more vertical market (inaudible) the sales model has gone up a bit. Obviously in more recent time here the additional ESG has been diluted to our short term earnings but the expectation is that we will make a good additive part of the business.

Okay. Thank you.

Also, if you think of that compared to our peer group we are still substantially more profitable and robust margin structure than any of our peers I think.

I understand. Thank you.

We have a follow-up question from Jeremy Grant with Stanford Group. Please proceed with your question.

Thanks. Just wanted to talk a little bit more about ESG. We talked about how Q3 adjusted EBITDA basis should be break even or pretty close to it. Wondering what revenue run rate you would have to be at in order to actually be break even on sort of a normal EBIT basis?

I think you can go back and do the math on that but at this point I think we are again focusing on the third quarter and on a cash flow basis that the numbers we projected were in the ballpark of being cash flow positive. It is sort of the direction we are at right now.

All right. Thanks.

Our next question comes from Richard Davis from Richard Davis & Company. Please proceed with your question.

I'm intrigued with the possibilities particularly in the direct store delivery market, around [writing] markets. How the customers saves money. Somebody mentioned that on a call and I thought to just expand that point a little bit.

Sure, Richard. This is Mike. I would be happy to do that. That market is all about -- it is route management. You look at what's going on in that space right now. Higher fuel prices. What these manufacturers are looking to do is get more routes completed in a typical eight-hour shift. Be more efficient on how those trucks navigate streets to save on fuel. And where we come into play is they wheel crates, cartons, boxes full of goods into a potential store and they are printing the transaction receipt on demand by wearing mobile printing devices and it saves that driver steps, valuable steps to walk back to the truck to get a receipt and that allows these companies to squeeze more deliveries into a day and it saves money, improves their efficiency and also ties to automating their billing system.

Thank you very much.

Our next question comes from Scott Scher with Clovis Capital. Please proceed with your question.

A couple of questions. The exit costs; what is your estimate for complete 2008 and then what do you think 2009 will be on the exit costs?

I don't think we have forecasted. The -- we said that the cost for -- exist costs for -- total costs. Not exit costs but total cost for the outsourcing project for 2008 was $16 million to $18 million. And that's still the forecast we have. And we said a total cost to the entire project was approximately the $25 million and we are also comfortable with that forecast at this stage.

So in theory in 2009 mathematically has to drop off quite significantly versus 2008?

Correct.

That's correct?

Yes, that's correct.

Okay. Then when you talk about the ESG and talking about it kind of improving here in the back half of the year. Is it too early to talk about 2009 in terms of the ramp for profitability because I know you have goals out there that you laid out to analysts day by 2010 or '11 to have it 15% margins or something like that. I'm not sure if that's linear or not. Is it too early to talk about ESG what the improvement will be in 2009 versus 2008 in terms of profitability?

I think it is too early to get into forecasting 2009. We expect the business to improve revenues and improve margins but I don't think we are quite comfortable giving any more specific targets at this stage.

Were there any other extraneous costs in the quarter in terms of severance for management? Were there any other expenses in this quarter that were extraordinary?

Yes, there were certainly severance expense in the quarter. We normally have some severance expense but a severance expense line was higher this quarter than normal.

Okay. Thank you.

This is Doug. We have time for one more question. And then we will be around certainly to answer your questions offline. Also, just as a reminder. Our next conference call will be held on October 29th.

Our last question will be from Richard Glass with Morgan Stanley. Please proceed with your question.

I have another form of a kind comment and question that you got a little bit earlier. All we are hearing on this call is that we are seeing growth in the printers, we are seeing growth in ESG, we are seeing growth in Asia. That's all well and good but as stockholders we would actually like to see some profits. You have had a languishing earnings number for years. You have had a languishing stock for longer than that. Maybe there needs to be a change in focus from just purely growth to actually worrying about driving the bottom line and talking about goals three years out is nice but it is difficult to see it from where we are seeing today. And maybe there needs to be a different set of incentives for management in terms of getting to profitability.

Looking through the proxy it seems like it's very growth focused and absolute operating income based as opposed to return based or profitability based. How are we going to change our focus and when are we going to start seeing an eye on profits being what matters and not just on growth?

So, first on the incentive that we have as a management team. We are very much incented to improve the share price so that will be a return and certainly aligned with you. That's the biggest part of certainly my compensation and very substantial part of everybody on the executive team's view.

We have a number of very significant activities that are looking to drive profitability as I mentioned. Outsourcing is something that can generate $25 million to $30 million of cost savings. The ERP program can certainly drive a lot of synergies. I wish that we could implement those in a quarter or two but those are large projects and it is going to take some time to get those done. But also I think we need to balance it with trying to get some growth for the business and make sure that we expands our marketplace and I think so far executed well on those plans and that should generate good long-term returns. If you look at our -- if you back out the cost for our outsourcing we have a pretty substantial improvement in EPS year-over-year.

Thank you.

I would like to turn the call back over to management for closing comments.

With that, thank you very much. Again, we will talk to you again on October 29th and if you have any questions we will be around to talk to you offline. Thank you very much.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.