Zebra Technologies - Q2 2013
August 6, 2013
Transcript
Operator (participant)
...Good morning, and welcome to the Zebra Technologies 2013 second 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 will be in a listen-only mode until after today's presentation. Instructions will be given at that time in order to ask a question. At the request of Zebra Technologies, this conference call is being recorded. Should anyone have any 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.
Douglas Fox (Head of Investor Relations)
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 we 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.
Anders Gustafsson (CEO)
Thank you, Doug, and good morning, everyone. Today, Zebra reported second quarter sales of $253 million and earnings of $0.60 per share, excluding $0.03 per share in exit and restructuring costs and acquisition expenses. Sales increased 2.5% from a year ago, $60 million, or 7% from the first. Sequentially, sales increased in all geographic regions. Second quarter revenue-
Operator (participant)
Okay. We go from the top again?
Anders Gustafsson (CEO)
Yeah. Sorry about that. I guess nobody could hear me, so we've changed microphones. We'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 a year ago, and $16 million or 7% from the first quarter. Sequentially, sales increased in all geographic regions. Second quarter revenue growth reflects the positive impact of Zebra's ever sharper focus on serving the needs of our customers, as well as a modest improvement in business conditions, albeit still challenged by uneven global economic growth. Our sales also reflect a small continuation of inventory decline at our distribution partners.
Second quarter results further demonstrate our ability to capitalize on Zebra's 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 subregions demonstrated year-over-year sales improvements. High growth in the U.K. 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. 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 for 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 ZXP 1 and enhancements to our ZXP 3 card printers.
These introductions follow the first quarter launch of the ZXP 7, which has received excellent response from customers and channel partners and is building a healthy pipeline. Enhancements to the ZXP 3 include the addition of Zebra's Print Touch near field communications module. This innovative feature enables easier printer setup, operation, and troubleshooting to enhance the user experience. We also further strengthened our innovative mobile printer line with the next generation of our EM220 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 in baseball stadiums for ticket and receipt printing.
Last week, we introduced MotionWorks sports software, a new and exciting player tracking solution. By combining our ultra-wideband real-time location system with our proprietary MotionWorks sports software, this innovative solution identifies and tracks players on the field in real time to within a few centimeters, providing for the industry's highest level of accuracy. The MotionWorks software enables visualization capabilities and data along XYZ axes on such information as distance traveled, 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, soccer, 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 wristbands are increasingly essential as healthcare organizations invest in technology to connect patient information with electronic healthcare records for improved patient safety and increased 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.
Michael Smiley (CFO)
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 in 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, decisions 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 costs. Let's take a look at 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 2 cents per share. In EMEA, sales increased 4%. The growth was supported by sales to customers in a broad, broad range of industries. Sales for North America increased 2.8% from a year ago. In the region, strong growth in supplies offset a modest decline in hardware sales. Latin America, down $1 million, or 4%, had softer sales during the quarter to customers in Mexico and other parts of Latin America. This softness was partly offset by growth in Brazil. Sales growth of 3% in Asia Pacific was broad-based, with nearly every sub-region contributing to the improvement. By 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 increased. Revenue from services also advanced for the quarter, up 7%. We expect further growth in service revenues over time 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 margin was 47.8%, compared with 48.7% last year. Product mix, including proportionally more supplies and pricing, had the largest impact on gross margin.
Also, to a lesser degree, profitability was temporarily affected by incentive pricing to move inventories of older versions of recently updated printers. Total operating expenses increased 4% from a 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. Quarterly operating income of $36.6 million, plus depreciation and 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.
The effective income tax rate for the second quarter was 19%. The 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 for acquisition expenses and exit and restructuring costs on 51.3 million average shares outstanding. At the end of the second quarter, we had 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 declined $7 million, bringing the total decline year to date to $14 million. From its peak in the 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 a $12 million increase in payables as part of a more deliberate strategic approach to managing working capital. On receivables, which were largely unchanged from the first quarter, the days 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 at a weighted average price of $45.71 per share. We ended the period with $454 million of cash in 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 the range of $253 million-$263 million. This outlook incorporates usual summer seasonality and EMEA. Earnings are expected in the range of $0.61-$0.71 per share. Our forecast assumes a consolidated gross margin in the range of 47.5%-48.5%. A projected improved product mix is expected to be offset by higher freight costs to address some of the lower than 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 (CEO)
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 accomplished this by first, introducing more innovative printers and asset tracking solutions to serve more of our customers' visibility requirements. Second, entering new markets with attractive growth opportunities. Third, penetrating more deeply the existing markets we serve. 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 on our investments in new growth platforms. These adjacent areas build on the strength and brand of our core business and are expanding the total available market for Zebra's products and solutions. Zebra Commerce, with its broad range, 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 sports 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 and 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 and 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.
Michael Smiley (CFO)
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 (participant)
At this time, we'll begin the question and answer session. If you'd like to ask a question, please press zero, then one on your telephone touchpad. If you're using a speakerphone, you may need to pick up the handset prior to doing so. Once again, if you have a question, press zero, then one on your telephone touchpad. One moment while the questions register.
Anders Gustafsson (CEO)
Everything must have been very clear.
Operator (participant)
Our first question comes from Andrew Spinola.
Speaker 5
Yeah, hi, thanks. I was wondering if we could drill down a little bit on the gross margin in the quarter, and also specifically, I, I'm thinking about your guidance for Q3, 47.5%-48.5%. And I'm wondering if you're, you expect to see any of the similar impacts that you saw in Q2, also in Q3?
Michael Smiley (CFO)
Yeah, this is, this is Mike. First of all, for Q2, I think one thing you have to understand is that we, you know, when you look at sort of what we ended up with, with revenue, we are really pleased to, we were pleased to hit our revenue target. In part, we were able to achieve that because we were pursuing larger government deals. And those government deals, typically on the hardware sale, is slightly lower margins, but they have a higher proportion of service attach rate, which over time will benefit our PNL. So it's a decision we chose, to, to, to help build our business.
But, you know, I think the other thing is that it provides us inroads into the government in the longer term, which is something as a company, we don't have as great of a market share as maybe some others in the business. We also have the mix of our sales was towards the lower end with supply, 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 mix. And then in this year, it's been a little bit more of the lower margin stuff that sells.
So it comes and goes, depending upon geography or depending upon industry that we're serving. I think the thing that pleases me with our margin is that, you know, this again, reflects the diversity of our business. Though, although perhaps retail was a little bit, lower than we'd hoped for, we were able to to overcome that with higher government and T&L, which affected our margin, for the quarter. So I think, in the longer term, we expect, you know, to continue to be in the 48%-50% range. Maybe Anders can give a little more color on that.
Anders Gustafsson (CEO)
Yeah, I think over the longer term, we still feel that the target we've laid out, the 48%-50% gross margin, is appropriate. You know, that is what we are working towards, and those are the goals we've set ourselves. But in any quarter, you know, we expect to see some shifts in mix and, you know, between products or geographies. And we have many quarters where we have, you know, more positive things. Things kind of go out- go break our way more. In Q2, we had a bit more pressure.
But we are also putting a lot of effort into making sure that we, you know, improve both the price points of our products, the type of products we sell, to drive improved margins, as well as, you know, significant effort on driving material cost reductions, to reduce our cost of materials. But over time, you know, over the longer timeframe here, we do expect that we'll also see a higher proportion of software and services revenue from our Internet of Things-related activities.
Speaker 5
Got it. 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 inventory at distributors, and I'm wondering what you're seeing, in terms of that, possibly in Q3 and going forward. Do you expect that your distributors to continue working down the inventory?
Anders Gustafsson (CEO)
Our expectation is that they will be neutral, so, you know, sales in and sales out should be equal, and so we don't expect there to be a further reduction.
Operator (participant)
Okay, thank you very much.
Anders Gustafsson (CEO)
Yep.
Operator (participant)
Our next question comes from Brian Drab.
Speaker 6
Good morning.
Anders Gustafsson (CEO)
Hey, Brian.
Speaker 6
Good morning. First question, a follow-up on that last point regarding inventory. Can you quantify what you saw in terms of the inventory decline at your industry partners? And if you don't want to quantify it specifically, could you just say directionally, was it higher or lower or, you know, less of an impact than it was in the first quarter?
Michael Smiley (CFO)
So, we don't want to quantify it particularly, but I can say it was somewhat less than it was in the first quarter, yeah, in the first quarter.
Speaker 6
Okay. Less than half of the impact in the first quarter, or just a little bit less than the, the first quarter?
Michael Smiley (CFO)
A little bit, a little bit less than in the first quarter.
Speaker 6
Okay, so still a pretty significant headwind then in this period?
Michael Smiley (CFO)
Yeah.
Speaker 6
Okay. And then, just looking at the top line, can you help us understand what revenue did on an organic basis, adjusting for the LaserBand acquisition? Because I know that was a $24 million revenue business in 2011. I imagine that contributed, what, about $7 million in sales in the quarter or so.
Michael Smiley (CFO)
Yeah, I don't think we break it out in detail, but it's obviously a very small part. It would be less than 1%, I think. What?
Speaker 6
Okay.
Michael Smiley (CFO)
Yeah.
Speaker 6
What I'm trying to get to, just, is it fair to say that on an organic basis, taking the acquisitions out of the picture, that revenue is, you know, flat to maybe down 1% on an organic basis in the second quarter, year-over-year?
Michael Smiley (CFO)
Well, you know, So again, we're not quoting, we haven't been breaking out the LaserBand revenue. I think, though, that you've got sort of two competing things. One is we had FX year-over-year negatively affecting us by the tune of about $1.3 million, offset by, you know, the LaserBand stuff. So I think we had a little bit of come and go.
So, it's, you know, obviously, the LaserBand helped us a little bit in the quarter relative to the year ago.
Speaker 6
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 in Europe and so if you talk a little bit more about what you saw in Italy and U.K. retail, because it looks like that was a great source of strength, and that you guys are doing very well there. Thank you.
Michael Smiley (CFO)
Yeah. So in, in Europe, the majority of our subregions were up in, in Europe. I think it was nine out of 13 subregions that were up. We saw particular strength in, you know, Germany, U.K., and Italy, which have been historically, you know, our strongest and largest, markets. And I would say over the last year, you know, Q2 of last year was a difficult quarter for, for Europe. But since then, the volatility in the region is, is, much lower, actually, and we've seen a slow but steady improvement. So I feel cautiously optimistic about Europe as we, you know, look into the second half of the year. You know, Q3 is obviously 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 quiet confidence for the second half. And maybe Mike Terzich would like to add some further color.
Michael Terzich (SVP of Global Sales and Marketing)
Okay, sure. Thank you. Brian, the only point I would add to what we're seeing in Europe is from a retail perspective, we certainly have seen some stabilization. In particular, you know, I think we're still benefiting from some strategic shifts. You know, we're gonna go 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 two retail climate, particularly emanating out of the U.K., 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 lifts.
So, things look pretty good relative to what we foresee for the third quarter as well.
Operator (participant)
Thanks very much. Our next question comes from Michael Kim.
Speaker 7
Hi, good morning, guys.
Anders Gustafsson (CEO)
Good morning.
Michael Terzich (SVP of Global Sales and Marketing)
Good morning.
Speaker 7
Hi, good morning. Anders, you talked a little about today opportunities in the sports and recreation vertical, and yeah, hoping you could spend a moment just talking about you know, the characteristics that make this vertical particularly attractive and an appropriate area for investments. And you know, if you can speak to the upgrade cycle of certain product categories, or if it's a multi-product opportunity, and how you're pursuing you know, in terms of your go-to-market strategy.
Anders Gustafsson (CEO)
Yeah. So, we've announced, you know, we announced the MotionWorks sports solution last week, but even before that, we have had a number of installations and product in different sports verticals. So for instance, we have RFID card printers in a number of ski resorts, including Vail, to, you know, improve the efficiency of the lift systems, but also to provide, you know, enhanced customer experience or user experience, by having much more access to much greater data about the ski experience. But we also have our mobile printers, particularly in all sorts of stadiums, for ticketing and receipt printing. And this, the MotionWorks sports software we announced, is an enhancement to existing products.
So it really builds on our UWB real-time location systems that we acquired from MSSI a few years back. And then it's the majority of the location software comes from our WhereNet acquisition. And this, before we've actually put on the MotionWorks new software piece, it has been installed in soccer teams and ice hockey 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.
You know, it helps both in the sense of providing much more granular information that can be used for practice. You can do replays of, you know, the game the night before. You can look at specific plays. You can look at using this when you're doing recruiting. But also, maybe the biggest improvement is it comes to the fan experience. We can now offer, you know, fans a different experience with replays and, you know, tracking how all the individual players move on the field in real time and track all the statistics with this. So it really helps to diversify our business away from also from hardware to much more focused on services and software.
Speaker 7
Great. And as a follow-on, you know, would some of the acquisitions contributing to sports and recreation vertical and, you know, LaserBand, that acquisition being about a year under the belt, you know, can you talk a little about, you know, where you're focused in terms of strategic opportunities? You know, where are you, you know, focusing your attention? Is it in this vertical or, you know, healthcare? You know, maybe you could expand a little bit about some opportunities that you're focused on.
Anders Gustafsson (CEO)
Yeah. So I'll, I'll start now, hand over to, to Mike Terzich afterward. But for, for LaserBand specifically, you know, the focus is really around, healthcare. You know, we still feel that, that the solution is particularly well suited for healthcare, and there is a, 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.
Michael Terzich (SVP of Global Sales and Marketing)
Yes, that's right. Michael, a couple other points. You know, with LaserBand specifically, what it does for us is, you know, Zebra has always been very passionate about thermal printing technology. Obviously, LaserBand, excuse me, is a laser printing technology, particularly in some of the global international markets. It actually lowers the IT entry cost of healthcare to introduce wristbanding as part of a patient safety initiative. Primarily due to the fact that hospitals deploy large installations of laser printers today, and that gives us a drop-in tray replacement 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 to 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 a thermal banded solution as well as a LaserBand solution is by far the best in the marketplace. And we're really well positioned to take advantage of the trends we're seeing in those applications.
Speaker 7
And, you know, when you think about your product portfolio or technology offerings, you know, do you see, you know, an area where, you know, there might be a follow-on strategic consolidation opportunity to augment LaserBand or, you know, build out, you know, capabilities in travel and leisure or healthcare or sports and rec? Any portfolio additions that you see, you know, filling out over the next, you know, year or so?
Anders Gustafsson (CEO)
Well, one area that we have talked about consistently has been around supplies. We see, you know, LaserBand as part of our supplies portfolio, and we see that as being an attractive area for investments. It offers a nice annuity with attach rates to our printers, particularly internationally, where we today have a very, very low presence of supplies business.
Speaker 7
Great. Thank you very much.
Operator (participant)
Once again, that is zero, then one to ask a question. Our next question comes from Keith Housum.
Speaker 8
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 business is coming from? Was it coming from the healthcare sector? And then second, was it more geographical strength, one sector, one segment of the country or the world, I guess, lack of a better word, than another?
Anders Gustafsson (CEO)
So generally, our you know, our supplies business did well globally, you know, where we are, but obviously, we're much stronger in North America and in Europe. The healthcare was a big part of this. There you know, was a great strength there. And we also saw a strong performance from the you know, higher 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 can also provide some further details.
Michael Terzich (SVP of Global Sales and Marketing)
Yeah, Keith, you know, the, you know, our business, you know, we have strategically located roughly half a dozen converting locations around, you know, four in the United States, two are 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 Anders' 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, very 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's 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 marketplace. 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 within, as you can imagine, in a hospital, a lot of label use, a lot of it being very specialty, resistance to chemicals, bloods, 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.
Speaker 8
Okay, great. And then as a follow-up, the exit and restructuring costs you guys have for the quarter of $1 million 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?
Michael Terzich (SVP of Global Sales and Marketing)
The first question, certainly, a good chunk of the exit restructuring has to do with the manufacturing or supply chain shift to China. The second question, could you repeat that real quick?
Speaker 8
Yeah, I guess, when can we expect to see some of that come through to the margins? Should we see it coming through immediately, or is that going to be more, you know, built in over time?
Michael Smiley (CFO)
It'll be more built in over time. I mean, there's a transition that happens as you end up with people passing on knowledge and stuff going from point A to point B, but it will eventually manifest itself. And that's, you know, to Anders' point about our mar- as we talked about margins, in part,
... you know, we've got, you know, raw material cost reductions that we're benefiting from. And then our operating group is not only, you know, 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.
Speaker 8
Great, thanks.
Michael Smiley (CFO)
Mm-hmm.
Operator (participant)
Our next question comes from Paul Coster.
Speaker 9
Thanks for taking my question. Anders, how much revenue are you deriving from software sales today, and what is the growth rate associated with that?
Anders Gustafsson (CEO)
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, you know, relatively modest number. But we have put much more effort over the 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 gonna, you know, be helpful. I think the MotionWorks sports vertical applications, Zebra Commerce for our, you know, retail areas. And we have some other things that are going on also that we think will be very attractive to us. Maybe Mike can do the specifics.
Michael Smiley (CFO)
Yeah. The software revenue for the company is, you know, less than $2 million. It's not very large. I think the thing that at this point, as Anders was talking about, as we start selling more of the LS solution, there'll be definitely much more of a software content. I think the other thing we've been talking, you know, which will help us, you know, move towards Internet of Things type of solutions. I think the other thing we talk 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 than there was five or 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.
Speaker 9
Got it. Okay. And then, Anders, the retail outlook sounded quite good globally, but domestically, it wasn't quite what I was looking for. Maybe it's more noise than reality, but hearing a lot about, you know, this upgrade of point of sales in small to medium-sized retail using iPads and, and other mobile platforms. And it just seems that you should be benefiting from that. What's going on there, and can you sort of project out a little way as well as to what you think will happen?
Anders Gustafsson (CEO)
Yeah. So, I would say generally, we had a stronger performance with retail outside of North America. North America was the weaker side, but we had good growth with retail outside of North America. And in North America, the tier two retailers were particularly strong. And, as we look into the second half of the year, we also expect our tier two retailers to grow the fastest. You know, the retailers are... How do you say? Two trends that are holding back retail spend today. You know, one is just an overall modest economic activity.
You know, 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 were referring to, that, you know, retailers are making a lot of analysis today around how are they going to transition to a mobile point of sale solution, how they're going to make sure that they are chip and pin compliant, so compliant to the EMV 2 standard. I think those things are preoccupying retailers, and, they're holding off investing to some degree until they have gotten a better handle on exactly how they're going to roll out those solutions.
But, you know, we're now 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, for the second half of the year, our pipeline has been growing quite nicely, so we, we have more confidence that retail will be performing better in the second half than in the first half.
Speaker 9
Got it. Thank you.
Operator (participant)
Our next question comes from Andrew Spinola.
Speaker 5
Thanks. I just wanted to follow up on your comments on your own inventory that you made, that it sounds like your inventory's gotten lower than you expected, expected it to. 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?
Michael Smiley (CFO)
This is Mike Smiley. This is primarily the fact that, you know, as we mentioned, we had a stronger demand for meeting customers in our government and transportation and logistics vertical than we anticipated, less in 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 SKU than we expected of the other SKU, and so the inventory ended up being a little bit lower than we anticipated. 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 into 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.
Speaker 5
Got it. Then 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 has actually gotten better there, so maybe you can give us a little more color on that market. Thanks.
Anders Gustafsson (CEO)
Yeah, China was improved for us quite nicely in the second quarter. We saw manufacturing come back a bit 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've put the real effort into diversifying our business away from manufacturing or 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 balanced 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.
Speaker 5
Thanks.
Operator (participant)
Once again, that is zero, then one to ask a question. I'm showing no further questions at this time.
Michael Smiley (CFO)
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 for November fifth. Have a good day.