Zebra Technologies Corporation
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Good morning, and welcome to the Zebra Technologies 2013 2nd 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; and Doug Fox, Vice President, Investor Relations. All lines have been in listen-only mode until after today’s presentation. Instructions will be given at that time in order to ask your question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any objections, please disconnect at this time. At this time, I would now like to introduce Mr. Doug Fox of Zebra Technologies. Sir, you may begin.

[Doug Fox:]

Thank you. Good morning. Thank you for joining us today. Certain statements made 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 issued this morning and are also described in Zebra’s 10-K for the year ended December 31, 2012, which is on file with the SEC. Now, let me turn the call over to Anders Gustafsson for some brief opening remarks. Okay, should we go from the top again?

[Anders Gustafsson:]

Yes. Sorry about that. I guess nobody could hear me so we’ve changed microphones. I’ll go from the top again. Thank you, Doug, and good morning everyone. Today, Zebra reported second quarter sales of $253 million and earnings of $0.63 per share, excluding $0.03 per share in exit and restructuring costs and acquisition expenses. Sales increased 2.5% from year ago, and $60 million or 7% from the first quarter. Sequentially, sales increased in all geographic regions. Second quarter revenue growth reflect the positive impact of Zebra’s ever sharper focus on serving the needs of our customers as well as the modest improvement in business conditions, albeit, still challenged by uneven global economic growth. Our sales also reflect a small continuation of inventory decline at the distribution partners. Second quarter results further demonstrate our ability to capitalize on Zebra scale, financial strength and industry leadership by aggressively advancing important business objectives for the company’s long term success. We pursued and won key new business with strategic customers in targeted verticals in an environment still challenged with a low level of large enterprise deals. While these wins temporarily affected gross margin, they secured important long term relationships with key customers for Zebra. During the quarter, we temporarily increased spending to capture targeted emerging business opportunities with exciting new applications for sports and recreation. This move has positioned Zebra in an important new market with innovative solutions incorporating greater software and services content. It is one of several key growth initiatives that build on our internet of things strategy, and will generate incremental revenue growth for Zebra in adjacencies to our core business. While modest during the early stage, we expect revenues from these new initiatives to begin developing in the second half of 2013 and accelerating in 2014. Overall, our diversity across geographies, products and customers, continued to benefit Zebra in the second quarter. In North America, strength among customers in transportation and logistics, healthcare, and manufacturing offset slower sales to customers in retail. In EMEA, the majority of the sub regions demonstrated year-over-year sales improvements. High growth in the UK was supported by increasing shipments to customers in retail. In Italy, strong growth was led by sales to the Italian post and customers in T&L and manufacturing. In Latin America, improvements in Brazil offset weakness in Mexico, and other parts of the region. And in Asia Pacific, we were encouraged by improving trends in South Korea, China, Australia, and Southeast Asia. In this region, we experienced improved diversification of Zebra’s business in government, retail and T&L. Together with an uptick in shipments to in country manufacturers or some product refreshes. As we have noted in the past, we continue to pursue our vision and drive growth through five strategic pillars; first, intensify innovation, second, expand into new markets, third, penetrate further into existing markets, fourth, maximize operational effectiveness, and lastly, inspire our people and culture. Let me now highlight some areas of progress in the second quarter relative to our strategy. The cadence of innovation, a cornerstone of Zebra’s strategy remains high. During the second quarter, we completed the refresh of our family of security and ID card printers with the introduction of the light duty ZXP1, and enhancements towards ZXP3 card printers. These introductions follow the first quarter launch of the ZXP7 which has received excellent response from customers and channel partners, and thus building a healthy pipeline. Enhancements to the ZXP3 include the addition of Zebra’s print touch near field communications module. This innovative feature enables easier printer set up operation and troubleshooting to enhance the user experience. We also further strengthen our innovative mobile printer line, with the next generation of our EM 220 mobile receipt printer which supports our mobile point of sale applications. It works with the latest smartphone and tablet operating systems, including Apple IOS, Android, Windows Mobile, and Blackberry. During the second quarter, we further expanded our presence in sports and recreation. Zebra card and receipt printers are already in use in multiple sports venues around the world, including RFID card printers on the ski slopes at Vail and mobile printers and baseball stadiums for ticket and receipt printing. Last week, we introduced motion works, sports software, a new and exciting player tracking solution. By combining our ultra wide band real time location system with our proprietary motion works, sports software, this innovative solution identifies and tracks players on the field in real time within a few centimeters providing for the industry’s highest level of accuracy. Motion works software enables visualization capabilities and data along X-Y-Z axis on such information as distance travelled, speed, and vertical leap. Our superior athlete tracking capability and real time analytics clearly set us apart from the competition. In 2012, we began testing our real time location sports solution, and we are now expanding to pilots. The solution is ideal for team sports such as football, software, hockey and basketball as well as individual and motor sports. Zebra’s real time location sports solution is an exciting example of how we are positioned to benefit from the major internet of things technology trends such as big data, cloud computing, and next generation analytics. During the second quarter, we also advanced activities to further penetrate the existing markets we serve. In North America, Zebra continues to identify improved ways to serve our retail customers. To this end, we announced last week the creation of the Zebra commerce brand. Zebra commerce is a coordinated approach to delivering Zebra solutions and services along with those of our strategic partners to meet more of our customers’ needs in retail and mobile enterprise. The acquisition of StepOne Systems late last year, brought to Zebra a suite of in store mobility software applications. Price management escorted gift registry and stock room management are some of the software applications that StepOne has installed with retail customers. Through Zebra commerce, we will be offering these and other applications along with Zebra hardware and services. In EMEA, we are serving more customers in healthcare. Our efforts include expanding sales resources with Zebra’s LaserBand product line supported by Zebra’s distribution capacity in the region. The additional sales resources are enabling us to reach more hospitals and other healthcare institutions across the region. Printed wrist bands are increasingly essential as healthcare organizations invest in technology to connect patient information with electronic healthcare records to improve patient safety, and increase operational efficiency. We remain pleased with growth of the LaserBand product line and the contribution of our new team members since acquiring the company last July. In Asia Pacific, we continue to make progress in diversifying our business in China with more wins in government, healthcare and T&L. The products we introduced over the past two years are helping us gain new customers and build further brand leadership in the region. The success of these efforts makes us optimistic about further growth in Asia Pacific. Zebra enters the second half of 2013 with extended leadership in its core business and better positioned to benefit from the investments in new growth initiatives. Our strategies for long term success remain intact, and we continue to invest in those areas that position Zebra to deliver a broader range of solutions that enable our customers to gain greater visibility into their value chain. Now, I will ask our CFO Mike Smiley, to provide a detailed review of second quarter results and guidance for the third quarter of 2013. After Mike’s remarks, I will return for some brief closing comments.

[Mike Smiley:]

Thank you, Anders. Let me highlight some of the key components of Zebra’s results for the second quarter. My comments will principally focus on year-over-year changes on the performance of Zebra’s operations. First, we had sales growth in three out of four geographic regions. Second, gross margin was affected by product mix, decision to pursue select large business opportunities, and price reductions to reduce old inventories. And third, operating expenses include an acceleration of investments to expand further into sports and recreation, as well as exit restructuring and acquisition cost. Let’s take a look in sales. For the quarter, sales increased 2.5% from $247 million last year, to $253 million for this year’s second quarter. The impact of foreign exchange net of hedges reduced sales by $1.7 million year-over-year, or $0.02 per share. In EMEA, sales increased 4%. The growth was supported by sales to customers in a broad range of industries. Sales for North America increased 2.8% from a year ago and the region’s strong growth in supplies offset a modest decline in hardware sales. Latin America down $1 million or 4% had soft sales during the quarter, the customers in Mexico and other parts of Latin America. The softness was partially offset by growth in Brazil. Sales growth of 3% in Asia Pacific was broad base with nearly every sub region contributing to the improvement. Our product category hardware sales declined 3% with small sales declines in most printer categories. The decline in hardware sales was more than offset by 20% growth in supplies. In addition to the contribution from the LaserBand product line sales of thermal based wristbands, labels and receipts increase. Revenue from services also advanced for the quarter, up 7%. We expect further growth in service revenues overtime as we roll out more service initiatives worldwide. Average printer unit prices declined from $471 to $462 in the second quarter principally because of mix and selective pricing on some large deals. For the second quarter gross margins was 47.8% compared with 48.7% last year. Product mix and including proportionately more supplies in pricing has the largest impact in gross margin. Also, to a lesser degree, profitability was temporality affected by incentive pricing to move inventories of older versions of recently updated printers. Total operating expenses increased 4% from the year ago. A portion of the SG&A expense increase related to the LaserBand and StepOne acquisitions which occurred in the second half of last year. In addition, we had an incremental 1.1 million of amortization and 1.1 million in exit and restructuring costs. Total the operating income of 36.6 million plus depreciation in amortization of 7.7 million, totaled 44.3 million of cash earnings, or $0.86 per share of cash EPS. Second quarter results, include a $1.6 million favorable litigation settlement which is related to an investment loss that was recorded in prior years. The settlement is recorded in other income. Effective income tax rate for the second quarter was 19%. Rate reflects the impact of a greater proportion of our income that is generated in regions with lower tax rates. Earnings totaled $0.60 per share including a reduction of $0.03 per share per acquisition expenses and exit and restructuring costs on 51.3 million average shares outstanding. At the end of the second quarter, we have 50.8 million shares outstanding. More effective management over our working capital contributed to a strong $60 million in free cash flow. For the second quarter, inventories decline $7 million bringing a total decline year to date to $14 million. Permits [ph] peak in a fourth quarter of 2011, we have reduced inventories by $24 million. This reduction is slightly more than desired, is also a direct result of improving efficiencies we have achieved in our extended supply chain operations. Cash flow was also positively affected by $12 million increase in payables as part of the more deliberate and strategic approach to managing working capital. On receivables, which were largely unchanged from the first quarter the day sales outstanding for the second quarter were 59 days compared with 63 days. During the quarter, we returned $25 million to shareholders with the buyback of approximately 540,000 shares of Zebra stock in a weight of average price of $45.71 per share. We ended the period with $454 million of cash and investments with $200 million held in foreign accounts. Now let’s look at our third quarter forecast. We are forecasting 2013 third quarter sales in a range of $253 million to $263 million. This outlook incorporates usual summer seasonality in EMEA. Earnings are expected in a range of $0.61 to $0.71 per share. A forecast assumes a consolidated gross margin in the range of 47.5% to 48.5%. A projected improve product mix is expected the offset of higher freight cost to address some of the lower and desired inventory levels. Operating expenses are forecast between $81 million and $83 million. The forecast also assumes an effective income tax rate of 19.5%. That concludes my formal remarks, and thank you for your attention. Now here’s Anders for some concluding comments.

[Anders Gustafsson:]

Thank you, Mike. By using our considerable competitive advantages, Zebra extended industry leadership in an environment still facing various global business challenges. We secured stronger relationships with strategic customers and made further progress against the five pillars of our strategy for growth and long-term success. We accomplish this by first, introducing more innovative printers and asset-tracking solutions to serve more of our customer’s visibility requirements. Second, entering new markets with attractive growth opportunities. Third, penetrating more deeply the existing markets we served; and lastly, driving for greater excellence across the board to deliver improved customer service and optimize Zebra’s operational efficiency. While pursuing our growth goals, we will continue to carefully maintain effective control over operating expenses. And we will also direct our resources to those areas that will deliver the highest returns on our investments for the long-term benefit of our shareholders. At the same time, we will continue to execute stock buybacks and pursue acquisitions. Zebra will continue to benefit from its great diversity across products, customers, markets and geographies. Bright spots for the second half of 2013 include growing our business in retail, healthcare and government in Asia Pacific, as well as healthcare and supplies in North America and EMEA. We are optimistic about achieving increasing returns and our investments in new growth path forms. These adjacent areas build on the strength and brand of our core business and/or expanding the total available markets for Zebra’s products and solutions. Zebra commerce with its broad suite of solutions for retail including mobile POS is one of those areas. Following the trials currently underway, we expect to build momentum in the sport’s vertical as well. Importantly, these and other initiatives are building greater software and services content into Zebra’s revenue mix. Over the past year, we have expanded our global service capacity primarily in the area of product repair. With our new facilities in Brazil, China, Australia and several locations in Europe, our Zebra owned an independent contract service operations are supporting our customers for improved overall service. Let me finish by adding that we are confident in our business and the proven strategy we are following to create shareholder value. Zebra together with our partners is building a smarter, more connected global business community. The results of our actions also demonstrate that the internet of things and other emerging technology trends are creating new incremental revenue opportunities for Zebra. Stronger relationships with strategic customers and better penetration of established new industries make us optimistic about our core business as well. Thank you for your attention today. I would now like to turn the call back to Mike for Q&A.

[Mike Smiley:]

Thank you. Thank you, Anders. Before we open the call to your questions, let me ask that you limit yourself to one question and one follow-up. In addition, Doug and I will be available after the call for any further discussions.

[Operator:]

At this time we’ll begin the Question-and-Answer session. (Operator instructions)

[Mike Smiley:]

Everything must have been very clear.

[Operator:]

And our first question comes from Andrew Spinola.

[Andrew Spinola:]

Hi. Thanks. I was wondering if we could drill down a little bit on the gross margin in the quarter. And also specifically, I’m thinking about your guidance for Q3 47.5%, 48.5%, and I’m wondering if you expect to see any of the similar impacts that you saw on Q2 also on Q3.

[Mike Smiley:]

Yes, this is Mike. First of all, for Q2, I think one thing you have to understand is that we – when you look at sort of what we ended up with revenue, we are really pleased to – we are pleased to hit our revenue target in part. We are able to achieve that because we are pursuing larger government deals. And those government deals typically on the hardware sales slightly lower margins, but they have a higher proportion of service attach rate which over time will benefit our P&L. So it’s a decision we chose to help build our business. But I think the other thing is that it provides us inroads into the government in a longer term, which is something as a company where we don’t have as great of market share as maybe some others in the business. We also have a mix of our sales was towards the lower-end with supplies. So it’s a little bit of a mix shift. And one thing you’ll see is in our business, there’s times where we’re selling higher margin business more strongly certainly in 2010 or so our margins were much stronger because of the mix. And then this year it’s been a little bit more of the lower margin stuff that it sells. So it comes and goes depending upon geography or depending upon industry that we’re serving. I think that thing that pleases me with our margin is that – this again reflects the diversity of our business. Although perhaps retail was a little bit lower than we’d hope for, we are able to overcome that with higher government and P&L which affected our margin for the quarter. So I think in the longer term, we expect to continue to be in the 48% to 50% range. Maybe Anders can give a little more color on that.

[Anders Gustafsson:]

Yes, I think over the longer term, we still feel that the target we’ve laid out, the 48% to 50% gross margin is appropriate. That is what we are working towards and those are the goals we’ve set ourselves. But in any quarter, we expect to see some shifts and mix between products or geographies. And we have many quarters where we have more positive things and things kind of go out and break our way more. In Q2, we have been more pressure. But we are also putting a lot of effort into making sure that we improve both the price points of our products, the type of products we sell to drive and improve margins as well as significant effort on driving material cost reductions to reduce our cost of materials. But over time, over the longer time that I’m here, we do expect that we’ll also see a higher proportion of softwares and services revenue from our internet of things related activities.

[Andrew Spinola:]

Great. That’s very helpful. Thanks. And then just one follow-up for me would be, Anders, you called out some pressure on revenue in the quarter from further reductions of the inventory distributors. And I’m wondering what you’re seeing in terms of that possibly in Q3 and going forward. Do you expect your distributors to continue working down the inventory?

[Anders Gustafsson:]

Our expectation is that they will be neutral. So sales in and sales out should be equal, so we don’t expect that to be a further reduction.

[Andrew Spinola:]

Okay, thank you very much.

[Operator:]

And our next question comes from Brian Drab.

[Brian Drab:]

Good morning.

[Anders Gustafsson:]

Hey, Brian.

[Mike Smiley:]

Good morning.

[Brian Drab:]

First question to follow up on that last point regarding inventory. Can you quantify what use on in terms of the inventory decline at your industry partners? And if you don’t want to quantify it specifically, can you just say directionally, was it higher or lower or less of an impact than it was in the first quarter?

[Anders Gustafsson:]

So the – we don’t want to quantify it particularly, but I guess, it was somewhat less than the end of first quarter – yes, in the first quarter.

[Brian Drab:]

Okay, so less than half of the impact in the first quarter or just a little bit less than the first quarter?

[Anders Gustafsson:]

A little bit less than in the first quarter.

[Brian Drab:]

Okay. So still a pretty significant headwind in this period?

[Anders Gustafsson:]

Yes.

[Brian Drab:]

Okay. And then just looking at the top line, can you help us understand what your – what revenue did on an organic basis adjusting for the LaserBand acquisition? I know it was a $24 million revenue business in 2011. I have imagined that contributed a lot about $7 million in sales in the quarter or so.

[Anders Gustafsson:]

Yes, I don’t think we break it out in detail but it’s always a very small part. It will be less than 1%.

[Brian Drab:]

Okay. I think what I’m trying to get to is, was it fair to say that on an organic basis taking that acquisition out of the picture that revenue was flat to maybe down 1% on an organic basis in the second quarter year-over-year?

[Anders Gustafsson:]

So again, we’re not quoting – we haven’t been breaking out the LaserBand revenue. I think that you’ve got your two competing things. One is we had FX year-over-year negatively affecting us by the tune of about $1.3 million offset by the LaserBand stuff. So I think we had a little bit of a common goal, so it is, obviously, the LaserBand helped us a little bit in quarter relative to the year ago.

[Brian Drab:]

Okay. And I guess I’m not supposed to ask any more questions, but I just wanted to see if you could elaborate a little bit more on the strength that you saw on Europe and just hope you talk a little bit more about what you saw on Italy and UK retail because it looks like that was a great source of strength that you guys are doing very well there. Thank you.

[Anders Gustafsson:]

Yes, so in Europe, the majority of our sub-regions were up in Europe. I think it was nine out of 13 sub-regions that were up. We saw a particular strength in Germany, UK, and Italy, which I’ve been historically are strongest and largest markets. And I would say over the last year – Q2 of last year was a difficult quarter for Europe, but since then, the volatility in the region is much lower actually. And we’ve seen a slow but steady improvement. So I feel cautiously optimistic about Europe as we look into the second half of the year. Q3 is the always a traditionally slower quarter with vacations and other things in Europe. But our pipeline is improving and our team in Europe is very engaged and very solid. So we have some quite confidence for the second half. And maybe Mike Terzich would like to add some further color.

[Mike Terzich:]

Okay. Sure. Thank you. Brian, the only point I would add to what we’re saying in Europe is from a retail perspective, we certainly have seen some stabilization in particular – I think we’re still benefitting from some strategic shifts, we’re going to back to a lot of what we’ve been able to deliver to retail has been efficiency productivity solutions and they’re still making those investments. So that Tier 2 retail climate [ph] particularly emanating out of the UK was strong for us, but then we’re also seeing that middle-class phenomenon in pockets, smaller pockets of Europe today namely out of the Eastern Europe part of the Russia territory where we’re seeing a lot of retail lift. So things look pretty good relative to what we foresee for the third quarter as well.

[Brian Drab:]

Thanks very much.

[Operator:]

And our next question comes from Michael Kim.

[Michael Kim:]

Hi. Good morning, guys.

[Anders Gustafsson:]

Good morning.

[Mike Smiley:]

Good morning, Mike.

[Michael Kim:]

Energy talked a little bit about – hi, good morning. Energy talked a little bit about today opportunities in the sports and recreation vertical. And hoping you could spend a moment just talking about the characteristics that make this vertical particularly attractive in appropriate area for investments and if you can speak to the upgrade cycle of certain product categories if it’s the multi-product opportunity and how you’re pursuing in terms of Go-To-Market Strategy.

[Anders Gustafsson:]

Yes, so, we announced – we announced the MotionWorks sports solution last week, but even before that we have had a number of installations in product in different sports verticals. For instance, we have RFID card printers in a number of key resorts including Vail to improve the efficiency of the lift systems but also to provide enhanced customer experience or user experience by having much more access to much greater data about this key experience. But we also have our mobile printers particularly in all sorts of stadiums for ticketing and receipt printing. And this MotionWorks sports software we did announce is an enhancement to existing product. So it really builds on our UWB real-time location systems that we acquired from MSSI few years back. And then it’s – the majority of the location software comes from our relative [ph] acquisition. And before we’ve actually put on the MotionWorks new software piece has been installed in software [ph] teams and IOSCO teams outside of the US. But now we’ve developed what we call the MotionWorks sports software functionality, which really is a way to much better provide visualization and to do much better real-time analytics about the movement of players or whatever you want to track in a sports arena. So this has great opportunities or great benefits for sports. And it helps both in the sense of providing much more granular information that can be used for practice. You can do replace of the game the night before, you can look at specific place, you can look at – they’re using this when you’re doing recruiting. But also maybe the biggest improvement is it comes to the fan experience. We can now offer fans a different experience with replace and tracking how all the individual players move on to field in real-time and track all the statistics with this. So it really helps to diversify our business, a way from also from hardware to much more focus on services and software.

[Michael Kim:]

Great. And as a follow on with some of the acquisitions concerning in the sports and recreation vertical and LaserBand that acquisition being about a year underdeveloped, can you talk a little bit about where you’re focus concerning strategic opportunities, where you’re focusing your attention, is it in this vertical or healthcare, maybe you could expand a little bit about some opportunities that you’re focused on.

[Anders Gustafsson:]

Yes, so I’ll start and I’ll hand over to Mike Terzich afterward. But for LaserBand specifically, the focus is really around healthcare. We still feel that that’s – the solution is particularly well-suited for healthcare and there is a new fast-growing market that we want to make sure we capture as much market share from as possible in the early stages. But we also see opportunities to offer LaserBand solutions into entertainment, hospitality and other verticals like that.

[Mike Terzich:]

Yes, that’s right. Michael, couple other points, with LaserBand specifically, what it does for us is Zebra has always been very passionate about thermal printing technology, obviously, LaserBand is a laser printing technology particularly in some of the global international market. It actually lowers the IT entry cost of healthcare to introduce risk banding as part of a patient’s safety initiative, primarily due to the fact that hospitals deploy large insulations of laser printers today and that gives us a drop entry replacements opportunity in addition to the thermal bands where we see them coexisting. And both the thermal and the laser printed band, we’re seeing a lot more interest to Anders’ point in the recreational and in the hospitality space. So when you think about access to theme parks, recreation centers, swim with the dolphins, et cetera, there’s a lot of control that those entities want a place to make sure that the people that are frequenting the facility have paid their fair share at the gate as well as a lot of other extending hospitality applications with travel and leisure in the portfolio from both the thermal banded solution as well as the laser banded solution is by far the best in the market place and we’re really well positioned to take advantage of the trends we’re seeing in those applications.

[Michael Kim:]

And you know, when you think about your product portfolio or technology offerings, do you see an area where there might be a follow on strategic consolidation opportunities to augment LaserBand or build out capabilities in travel and leisure, healthcare or sports and recreation? Any portfolio additions that you see filling out over the next year or so?

[Anders Gustafsson:]

The one are that we talk about consistently has been around supplies. We see, LaserBand as part of our supplies portfolio and we see that as being an attractive areas for investment. It offers a new team with attach rates to our printers particularly internationally where we today have a very low presence of supplies business.

[Michael Kim:]

Great. Thank you very much.

[Operator:]

And once again, that is 0 then 1 to ask a question. Our next question comes from Keith Housum.

[Keith Housum:]

Good morning, gentlemen. Thanks for taking my call. Question for you on the supplies business and perhaps I just missed this, but can you guys narrow down a little bit more perhaps on where the strength in the supplies is coming from, was it coming from the healthcare sector, and is that with more geographical strength, one sector – one segment of the area, country or the world, I guess, for lack of a better word, than another?

[Anders Gustafsson:]

Generally, our supplies business did well globally where we are, but obviously, we are much stronger in North America and in Europe. The healthcare was a big part of this, so a great strength there. And we also saw a strong performance from the high quality more synthetic type labels that are used in manufacturing, higher margin products also. So overall, I think it was a very strong broad based performance from our supplies business and Mike Terzich is going to supply some further details.

[Mike Terzich:]

Yes, Keith, you know our business, we have strategically located roughly half a thousand converting locations around – four in the United States, two at present in Europe. And those converting locations today are serving that manufacturing, what we call the specialty manufacturing market and where Zebra tends to focus and where we differentiate to Ander’s point is on high end specialty materials. These are materials that are typically used in line, in manufacturing, labels that could withstand lots of harsh environments, high temperature in manufacturing processes, circuit boards, et cetera. So that allows us to play in a space that generally is higher margin, varied specialty and it differentiates us from lots of little converters that provide local supply to their customer base. The second part of our market segment has been the growing – and that manufacturing base by the way is growing. We think that there is a fair amount of consolidation going on in the vendor community over the course of time. And Zebra has certainly grown at a rate that is much greater than the material management forecast for specialty materials that are being produced in the market place. That second leg to our growth strategy has been around healthcare and the expansion of patient safety initiatives, but we’re also leveraging that healthcare team into selling into the healthcare institutions across the pressure sensitive label business as well. So as you can imagine in a hospital a lot of label used, a lot of varied specialty resistance of chemicals, blood, et cetera, that’s creating some more opportunity for us from a direct sale into a hospital fulfilled through our telesales organization that we acquired with LaserBand.

[Keith Housum:]

Okay, great. And a follow up, the exit restructuring cost you guys have, the quarter of a million bucks or so, I’m assuming that was further related to the Chinese supply chain. Please correct me if I’m wrong. And then second, when should we start to see some of the benefit from that, I guess to the margins?

[Mike Terzich:]

So the first question, certainly a good chunk of the exit and restructuring has to do with the manufacturing or supply chain ship to China. The second question, could you repeat that real quick?

[Keith Housum:]

Yes, I guess – when can we expect to see some of that come through to the margins? Do you see it come through immediately? Or is that going to be more you know, built in over time?

[Mike Terzich:]

It will be more built in over time. I mean the transition that happens is – end up with people passing on knowledge and stuff going from point A to pointy B, but it will eventually manifest itself. And to Anders’ point about – as we talked about margins, in part, we’ve got raw material cost reduction that we’re benefiting from and then our operating group is not only working really hard to manage our inventory better, but they’re also doing it more efficiently. So you know, we’re using that in part to help deal with you know, some of the pricing pressure we do periodically see.

[Keith Housum:]

Great, thanks.

[Operator:]

And our next question comes from Paul Coster.

[Paul Coster:]

Thanks for taking my question. Anders, how much revenue are you driving from software sales today and what is the growth rate associated with that?

[Anders Gustafsson:]

I got to look that up here. I don’t have that exactly at my fingertips. But it is a small number, it’s been growing, but it is a relatively modest number. But we have put much more effort over last couple of years to develop new solutions that have a much higher software content. And we talked about Link-OS as one of those, as the new operating system for our new printers, that’s going to be helpful. I think the motion works sports vertical applications, commerce for our retails areas, and we have some other things that are going also that we think will be very attractive to us. Maybe Mike – to the specific –

[Mike Terzich:]

Yes. The software revenue for the company is you know, less than $2 million. It’s not very large. I think the thing at this point, as Anders is talking about is we start selling more of the OS solution, definitely much more of a software content. I think the other thing we’ve been talking, you know, which will help us move towards internet of things type solutions, I think the other thing we talked about is that our – the content of our products have a larger software component in them. So for example, our printers have a much greater degree of software in that product and then there was five of six years ago. So it’s a combination of software in our hardware solutions and specific software sales that we expect to see through our move into the internet of things.

[Paul Coster:]

Okay. And then Anders, the retail looks quite good globally, but domestically, it wasn’t quite what I was looking for. Maybe it’s more noise than reality, but I’m hearing a lot about you know, this upgrade of point of sales in small to medium size retail using iPads and other mobile platforms. It just seems that you should be benefiting from that. What’s going on there and can you sort of project little ways as to what you think will happen?

[Anders Gustafsson:]

Yes, so generally, we had a stronger performance with retail outside of North America. North America was the weaker side, but we have good growth with retail outside of North America. And in North America, the pier two retailers were particularly strong. And as we look into the second half of the year, we also expect our pier two retailers to grow the fastest. The retailers – two trends that are holding back retail spend today. One is just an overall modest economic activity, so they’re all very nervous about making larger capital commitments so they tend to divide their projects into smaller pieces and spread them out over a longer period of time, so we don’t get as many of the larger enterprise deals as we used to. The other one is the point that I think you are referring to that, retailers are making a lot of analysis today around how are they going to transition to a mobile point of sales solution, how they are going to make sure that they are chip and pin compliant, compliant to the EMB2 standard. I think those things are pre occupying retailers and they’re holding off investing to some degree until they have gotten better handle on exactly how they’re going to roll out those solutions. But we’re not trying to make sure we can position ourselves well to participate in some of those new areas. It really reinforces our focus on internet of things like technologies so as we have with the Zebra commerce and specifically for the second half of the year, our pipeline has been growing quite nicely. So we have more confidence that retail would be performing better in the second half and in the first half.

[Paul Coster:]

Thank you.

[Operator:]

And our next question comes from Andrew Spinola.

[Andrew Spinola:]

Thanks. I just want to follow up on your comments on your own inventory that you made. It sounds like your inventories gotten lower than you expected it too. And I was wondering what would be the driver of that? Is that possibly a pickup of demand near the end of the quarter or maybe just sort of late shipments on new products?

[Mike Smiley:]

This is Mike Smiley. This is primarily affected – as we mentioned we had a stronger demand for meeting customers in our government and transportation on logistics vertical than we anticipated less than retail. So effectively, the mix we forecasted for products was a little bit different than what we actually resulted in. So as a result, we ended up using more of one skew than we expected of the other skew. And so the inventory ends up being a little bit lower than we anticipate. I think this is something that’s just normal in the business. Sometimes you’re good at guessing where it is, sometimes not. So the only reason we really bring it up is just to let you know that when we go on the third quarter, our gross margin looks relatively – we’re forecasting relatively flat gross margins in the third quarter relative to the second quarter and that’s because in part we expect to have to pay more in freight to build up some of those inventories to levels that will allow us to continue to serve our customers the way we want to.

[Andrew Spinola:]

Got it. And then the last question for me. We’ve heard some companies talk about sort of developing weakness in China. And I was wondering, it sounds like your business actually gotten better there. So maybe you can give us a little more color on that market. Thanks.

[Anders Gustafsson:]

Yes, China was improved for us quite nicely in the second quarter. We saw manufacturing come back of it because that’s been a weakness in China for us. So we’ve been so exposed to manufacturing over the years. But over the last two years, we put the real effort into diversifying our business away from manufacturing and making us less dependent on manufacturing. And we’ve seen a really nice growth in our business in healthcare, in retail and government. So we have a much better balance to business today than we’ve had before. And that gives us also some better confidence that we will be seeing more growth as we go forward from China.

[Andrew Spinola:]

Thanks.

[Operator:]

(Operator instructions) I’m showing no further questions at this time.

[Doug Fox:]

Okay. With that, thank you all for joining us today. I’d like to let you know that our next regularly scheduled conference call will be for our third quarter earnings which is currently scheduled on November 5th. Have a good day.

[Operator:]

And thank you for attending today’s conference. You may now disconnect.