Zebra Technologies - Q2 2014

Transcript

Operator (participant)

Good morning and welcome to the Zebra Technologies 2014 second quarter earnings release conference call. Joining us from Zebra Technologies are Anders Gustafsson, CEO; Mike Smiley, CFO; Mike Terzic, 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 like to introduce Mr. Doug Fox of Zebra Technologies. Sir, you may begin.

Douglas Fox (Head of Investor Relations)

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 latest 10-K, 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. I am pleased to report that Zebra achieved another quarter of record sales, $288.4 million, up 14% over a year ago and at the upper end of our guidance range. Non-GAAP net income of $0.84 per share was up 35% from $0.62 per share for the second quarter of 2013. We maintained strong gross margins and generated $55 million in free cash flow. All around, the second quarter was another very solid period for Zebra. Our sustained success demonstrates strong execution capabilities against a proven growth strategy. Virtually all facets of our business met or exceeded our performance expectations as we further penetrated targeted industries more deeply and maintained our focus on delivering more innovative solutions to our customers.

We also made solid progress on integration planning for day one readiness, our first priority for the acquisition of the Motorola Solutions enterprise business as we lead up to closing. Ongoing strength in our core run rate business and further improvements in large enterprise deals characterized second quarter activity. All geographic regions contributed to the sales growth. In North America, shipments to customers in retail and transportation and logistics remained buoyant. An uptick in core printer shipments partially offset the expected seasonal decline in revenues from Hart Systems. In Europe, further improvements in economic activity led to our third consecutive quarter of record sales, propelled by strength in the UK and Germany. And in Asia, further diversification of our customer base supplemented improved shipments to manufacturing customers. We also made good progress on integration planning for the acquisition of Motorola's enterprise business.

Since announcing the deal on April 15, we established and staffed our integration planning office with teams across all business disciplines, fully engaged in activities to prepare for day one as a combined entity. Our first priority has been and will continue to be the ongoing success of our combined organization. We have worked diligently to identify and start to address all critical areas of improvement and change needed to ensure this objective. We are very pleased with the progress we are making on the complex process of acquiring a carve-out business. In addition, we recently announced the passing of the Hart-Scott-Rodino review waiting period, a key milestone. We expect to complete the transaction by year-end. Let me now highlight some areas of progress in the second quarter. In all geographies, Zebra has benefited from deeper penetration of targeted verticals.

We continue to forge tighter, more strategic relationships with established and new customers who increasingly look to us for products and solutions that help them gain greater visibility into their business operations. To this end, both new and established Zebra products gained traction. In North America, we had 16% sales growth with notably strong sales of mobile printers. Large deal activity included shipments of our popular QLn320 mobile printer and our PS4000 wireless print server to retail customers. Our innovative location solutions products also had a solid quarter with improving shipments to industrial customers who are increasingly taking advantage of the power of active RFID for asset location and motion management. In EMEA, nearly all subregions experienced sales growth, which led to 16% growth in this region as well. Large deal activity included shipments of our compact MZ 320 mobile printer into postal applications.

Of particular note, we had a very successful launch of our new ZT400 series mid-range tabletop printer in the region with good uptake by retail and manufacturing customers. Healthcare also stood out with strong sales of our HC100 thermal wristband printers, as did our broad range of thermal and laser wristband products. In Latin America, we had modest sales growth of 4%, in part due to a challenging economic and political landscape in several countries. Growth in Brazil was the most challenged, with some impact from the World Cup. This performance was more than offset by growth in Mexico and other parts of Latin America. The region continued to be an area of strength for our card printer products, supported by some nice wins in Argentina and Ecuador for financial services applications.

Our Customer Applications Group was particularly helpful in working with a Latin American channel partner to tailor our card printers for these applications. We also had robust growth of supplies in the region. Large deal activity is picking up, supplementing a steady run rate business and providing for a favorable outlook for the second half of the year. Asia Pacific also registered another strong quarter, with sales up 9% on broad strength across the region, including a pickup in large deal activity. In India, card printers are supporting voter registration activities. In South Korea, a manufacturing recovery, along with favorable trends in transportation and logistics and healthcare, generated high demand for mid-range and desktop printers. In China, an improving manufacturing sector led to increased shipments of high-performance printers for mission-critical applications.

In addition, our diversification into the parcel delivery sector generated several deals for our desktop printers, specifically designed to meet the needs of customers in emerging markets. Solid execution on a proven growth strategy remains the foundation for Zebra's ongoing success. Our second quarter results demonstrate how we continue to extend our leadership through our focus on innovation to meet growing customer needs for asset visibility. Zebra is well positioned to benefit from the drive by enterprises for greater efficiencies in their supply chains by taking advantage of the Internet of Things and data analytics. The acquisition of Motorola's enterprise business will enable Zebra to play an even greater, more strategic role in Enterprise Asset Intelligence and mobility. Now, our CFO, Mike Smiley, will provide a detailed review of second quarter results and guidance for the third quarter of 2014.

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 second quarter results. First, we had record sales with strong organic growth and increases in all four geographic regions. Second, adjusted EBITDA increased by 38%. And third, results were favorably affected by a lower income tax rate. Now, let's take a look at sales performance. For the quarter, sales increased 14% from $253 million last year to a record $288 million. On an organic basis, sales increased 12.5%, with Hart contributing $3.6 million to the quarter as expected. Foreign exchange had a positive impact on sales of approximately $3.5 million net of hedges year over year. Sales for North America increased 16% to $129 million. In addition to the modest impact from Hart Systems, the result primarily reflects strong growth in hardware, with mobile printers for refresh and new applications performing best.

We also had growth in desktop and tabletop printers. In EMEA, sales increased 16% as well to a new record of $94 million. The improving economic picture in Europe led to a greater number of large projects to complement an ongoing strong run rate business, while broad-based shipments to retailers in the UK, manufacturers in Germany, and postal in Italy highlighted the quarter. Latin America's sales growth of 4% reflects some weakness in Brazil, Argentina, and Venezuela, which was offset by growth in other parts of the region. In Asia Pacific, we had solid 9% sales growth with increases across nearly all subregions and a broader range of customers and verticals as a result of our ongoing activities to diversify our business in the region. Underscoring the diversity of Zebra's business by product category, sales of hardware increased 14% and supplies advanced 10%.

Services and software revenue growth of 39% reflects the impact of the revenues from the Hart Systems acquisition, in addition to our organic growth of 11%. For the second quarter, gross margin was 49.3%, up from 47.8% a year ago. As I mentioned, the higher gross margin reflects the impact of higher volumes, lower inbound freight costs, and lower product costs. Net of hedges, favorable currency movements increased second quarter gross profit by approximately $2 million year-over-year. Sales and marketing, engineering, and administrative expenses increased less than 6% from a year ago compared with a 14% growth in sales. The growth in operating expenses was primarily related to higher compensation expenses, including those from the Hart acquisition. Hart accounted for approximately $3 million of the $5 million of year-over-year growth.

Total operating expenses also include $20 million in acquisition and integration costs, which lowered GAAP earnings by $0.30 per share. The amount was principally for professional fees and integration activities associated with the pending acquisition of the enterprise business. Also included in the quarter is a loss of $2.4 million in interest rate swaps. During the second quarter, we entered into a series of hedges to fix a portion of the interest cost associated with the anticipated floating rate borrowings for funding the acquisition. Interest rates decreased slightly since entering into the swaps. The effective income tax rate for the second quarter was 11.1%. The low rate reflects the impact of the acquisition and integration costs, which lowered income in the U.S. and increased the proportion of Zebra's income from lower tax jurisdictions. Excluding these items, the effective tax rate is roughly 20%.

Because of these changes and in anticipation of the acquisition, which will likely increase amortization, we've introduced non-GAAP measures to help investors gain a better understanding of underlying company performance. For the quarter, non-GAAP net income totaled 84 cents per share, up 35% from 62 cents per share for the second quarter of 2013. Quarterly adjusted EBITDA was $69.4 million, or 24% of sales, compared with $50.4 million, or 20% of sales last year. For the second quarter, inventories increased $6.7 million from the first quarter. Inventory turns increased from 4.7 times for the first quarter to 4.8 times for the second quarter. Net receivables declined $16.2 million from the first quarter. The day sales outstanding declined from 56 days to 52 days. We ended the period with $529 million of cash investments, with approximately 60% held in foreign accounts, all of which are invested in US dollar-denominated securities.

Now, let's look at our 2014 third quarter forecast. We are forecasting third quarter sales in the range of $285 million-$295 million, which represent an increase of roughly 10%. The forecast reflects the company's typical seasonality, taking into account the summer slowdown in Europe. Third quarter non-GAAP earnings are expected in the range of 81-91 cents per share. Our forecast assumes a consolidated gross margin in the range of 49%-50%. Operating expenses for the third quarter are forecast between $88-$89 million, excluding acquisition expenses. The forecast also assumes an effective income tax rate of 20%, which we use for our non-GAAP calculation. That concludes my formal remarks. Thank you for your attention. Now, here's Anders for some concluding comments.

Anders Gustafsson (CEO)

Thank you, Mike. Sharp execution across Zebra's business led to our strong second quarter results. We continue to demonstrate excellent progress against our strategic goals to drive profitable growth and position Zebra for long-term success. Our focus on innovation in a broader range of products and solutions is making Zebra a more important strategic partner to customers for their critical asset visibility needs. Customers in retail, manufacturing, healthcare, sports and entertainment, and other targeted industries are increasingly seeing the value in working with the industry leader with the strongest brand and global go-to-market channels. The foundation for Zebra's enduring success remains with our products and solutions. Our reputation for reliability, durability, and value continues to enhance our leading global brand and set the industry standard. During the first half of 2014, we introduced nine printer-related products to maintain a high cadence in this vital area.

We are on target to release an additional six to seven products in the second half of this year. In addition to the successful launch of the ZT series of tabletop printers, we announced two new mobile printers specifically designed to meet the needs of healthcare professionals. The QLn220 and QLn320 mobile printers are built with disinfectant-tolerant plastics for easy cleaning after each bedside use. The printers incorporate Zebra's Link-OS environment and have a multi-platform software development kit to enable easy compatibility with a variety of operating systems and other mobile devices. Healthcare remains an attractive growth market for Zebra as we continue to expand our offerings of printers, wristbands, and labels to improve patient safety and help providers deliver healthcare more efficiently. Our proprietary Link-OS environment is now embedded in 14 Zebra printer models since its introduction two years ago.

More than 100 apps have been created to run on Link-OS by Zebra and a growing number of independent software vendors. Our retail and healthcare customers, in particular, perceive great value in Link-OS as an easy and secure way to centrally manage their wireless Zebra devices. This is one example of how Zebra is moving beyond the printer to allow our customers to easily embed our technology into their business processes, which will enable them to realize greater efficiencies and make smarter decisions about deploying their assets. Another area of growing opportunity beyond the printer is in RFID. Last week, our location solutions business reached an important milestone. Building on a successful pilot last year, we recently announced a partnership with the National Football League to install Zebra's real-time location solution in 17 stadiums for the 2014 NFL season.

Our sports solution, using our proprietary MotionWorks software, will provide next-gen stats on player speed, position, and acceleration in real time. The data can then be used to generate new experiences, such as broadcast overlays of action on the field to enhance the fan experience. Our announcement with the NFL follows our announcement in May with Michael Waltrip Racing to deploy Zebra MotionWorks motor sports solution, a first-of-its-kind pit crew evaluation system. The value of motion management with high-quality, real-time information is clearly on the rise in sports. Zebra is well positioned with proprietary systems to help professional, collegiate, and other teams in practice and on game day. These solutions are excellent examples of how innovation is extending our core technology to have greater applicability across a broader range of solutions and verticals.

As we plan for the integration of the enterprise business, we will use our existing Zebra strategic framework as the foundation to drive improvement. Since announcing the transaction in April, we have been able to take a deeper look into possible synergy opportunities. Based on our analysis, we now expect to achieve run rate cost synergies of $150 million by the end of 2016. We will ensure laser-focused execution on the integration and management of the combined entity to create value for our customers and shareholders. The acquisition of the enterprise business will secure Zebra's leadership in enterprise asset intelligence. We will have the capacity to provide complete end-to-end solutions for our customers with leading global brands in scanning, mobile computing, and thermal printing.

With our broad range of solutions, including RFID, wireless LAN, and location solutions, Zebra will be well positioned as the company of choice for mobile solutions that enhance the visibility of assets within the enterprise and across the supply chain. Zebra will play an increasingly important role in helping businesses get the data that lead to better-informed decisions. Let me conclude by saying that we are very excited about the future for Zebra. We have multiple opportunities for profitable growth and high returns on investments. Zebra is well positioned to take advantage of important global trends in mobility, data analytics, and the Internet of Things. We will continue to focus on maintaining the high performance of our current operations as we plan for the integration with the enterprise business to deliver attractive returns for our shareholders. Thank you for your attention today.

I would now like to turn the call over to Doug for Q&A.

Douglas Fox (Head of Investor Relations)

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, Mike and I will be available after the call for any further discussions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. If you have a question, please press star, then one on your touch-tone phone. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star, then one on your touch-tone phone. Please wait while the questions register. Our first question comes from Brian Drab from William Blair. Please go ahead. Brian, your line is now open. We'll go on to the next question. Our next question comes from Andrew Spinola from Wells Fargo. Please go ahead.

Andrew Spinola (Analyst)

Thank you. I was wondering if you could comment on the Motorola results today. I don't know how much time you've had to look at them, but the enterprise business was down 8% versus roughly 1% in Q1. It sounds like Motorola thinks that it was mostly a one-time blip and that the business should grow for the year. Have you had a chance to look at that, and are you comfortable with what they're saying is going on in that business and the ability to return that business to growth?

Anders Gustafsson (CEO)

Yeah. So we've had some time to look at those numbers, and we were aware of what Motorola was going to say, I think, generally on their call. The underperformance, as far as we can understand, is driven by some performance issues around supply chain execution, some other integration execution issues around Psion, and sales execution in Asia with some demand as they see it. When we looked at those issues, they do seem to be something that are fixable with a good amount of focus. And we obviously will apply our singular focus to the business of being now a larger company in the Enterprise Asset Intelligence space. And we believe the underlying markets are performing quite well, and Q3 should be a stronger quarter.

They mentioned, I think, on their call that they have better backlog, had a lot of new good wins, particularly around Android devices at the beginning of the quarter. So we remain very excited about the overall acquisition and confident in our ability to generate good, attractive returns for shareholders.

Andrew Spinola (Analyst)

Is it fair to say that given the time you've had to look at that business, you're still comfortable with your 4%-5% growth guidance for the pro forma business going forward?

Anders Gustafsson (CEO)

Yes. We think that's a fair target for us. We're not prepared to change that at this stage. And we believe that we have a strong track record around execution and how to really focus our execution on driving value. And that's certainly something we will be doing as we go forward.

Operator (participant)

Our next question comes from Keith Housum from North Coast Research. Please go ahead.

Keith Housum (Managing Director and Senior Equity Research Analyst)

Thanks, guys in the call. Thanks for taking my question here. Yeah. I guess, Anders and Mike, can you guys provide a bit of detail about what drove the increase in the cost synergy expectation from $100 million to $150 million? And then what's the starting point for investors to look at? Is it the number that was provided in the 10-K on April 15th, or is it the number that we can back into based on the 10-K that Motorola provided last week?

Michael Smiley (CFO)

Yeah. So this is Mike Smiley. First of all, I think as we've had some time to sort of dig into the numbers, we've been able to spend some time on the cost of goods sold. And as a result of that, we see ourselves going from the $100 million to $150 million. I would say also we've been spending a lot more time sort of thinking through our plans of how we execute on those synergies. And as a result, we think that the run rate, when we get into 2017, will be roughly $150 million better off than they were in 2013. So that's sort of the direction that we're putting together, and we feel confident about that.

Keith Housum (Managing Director and Senior Equity Research Analyst)

Okay. And then can you remind me about the close? I think I heard you guys say you expected the deal to close by the end of the year, but I thought I recall from some conversations, perhaps with you guys, perhaps with investors, that they were thinking timing would be closer to the beginning of the Q4. What's the expectation for when the deal will close?

Michael Smiley (CFO)

So we've said the second half of the year is we've been working very hard in closing that transaction. Our first priority, and I think Mike Terzic can talk to that, is to make sure that we are able to continue to satisfy our customers when we close that acquisition. And so as we do that, we're trying to be focused in having a clean close. And so we've said the second half of the year, and we're confident that's what we'll do. Mike, do you want to add any color on that?

Mike Terzic (SVP, Global Sales and Marketing)

No, I think the only, I guess the only other point to that, Keith, is the second half is rapidly advancing, and the likely position for us is going to be fourth quarter on that close. To Mike's point, we're hard at work right now in the middle of lots of detailed integration planning to make sure we could stand that business up and run it effectively on day one.

Operator (participant)

Our next question comes from Brian Drab from William Blair. Please go ahead.

Brian Drab (Equity Research Analyst)

Well, I hope you can hear me now.

Michael Smiley (CFO)

Yeah. Hey, Brian.

Brian Drab (Equity Research Analyst)

Okay. I don't know what happened there. My mic was on. So first question, just on the retail strength that you continue to see, can you tell us today what percentage of your revenue, just for the legacy Zebra business, is coming from retail, roughly? And then is this strength coming more on the retail side, meaning, of course, distribution centers for online retailers, or is it on the traditional brick-and-mortar retailer side, or both?

Michael Smiley (CFO)

I think on a global basis, we think about 25% of our revenues come from retail. That's the broader number. It's been fairly steady. It's probably gone up a little bit this year as we've seen retail being one of our strongest performing verticals, but it's not radically different from what it's been historically. Maybe Mike can provide some extra color on the warehousing and other things.

Mike Terzic (SVP, Global Sales and Marketing)

Okay. Brian, no, I think Anders is right on the mark. It's about 25% globally. It's different in each of the geographic regions. We're enjoying certainly a very robust retail outlook and performance in North America. We're seeing Europe come back online and the smaller regions, Asia Pacific, Latin America. It's a little bit much more of a trailing effect, a little bit of a lift in Asia given the rising middle-class phenomenon that's underway. As far as the application space, a lot of what we're seeing has been more in line with the traditional applications where Zebra's been a little bit more in the aisle, back of store, back of room. There's been a long-overdue, somewhat borne-out-of-necessity requirement to refresh some aging technology, and that certainly has been put into play, and I think that's what we're seeing in the numbers.

Brian Drab (Equity Research Analyst)

Okay. Thanks. That's helpful. And then just given the recent press release on the NFL, and first of all, thanks for giving us some technology to make the NFL season even more fun. And can you talk a little bit about that, and is this going to be meaningful in terms of revenue? Are the broadcasters potentially going to mention Zebra, or is your name going to appear during the games? And when's the revenue? I know this is a lot of questions. When might the revenue hit? Q2, Q3? And can you talk at all about opportunity per stadium? I know you're putting sensors in all these columns throughout the stadium.

Michael Smiley (CFO)

Yeah. So first, we're very excited about the opportunity. We think it's a great example of highlighting the Internet of Things or Enterprise Asset Intelligence for us and how we can really bring visibility to operations, so to the physical world, and tie that back into applications and the internet. So we've been working with NFL for quite a long time to pilot the systems last year and then start rolling it out this year. The initial agreement here is to implement it in 17 stadiums. So it's first and foremost all the stadiums that have Thursday football night games, but all teams will be part of that. So this is for the NFL-wide. And our expectation is that we will roll it out for all the 31 stadiums later for this year also.

We aren't going to comment on the commercial terms, particularly here, but we are excited about the opportunity, and the revenue will start hitting second half of this year. For us, I think the big opportunity is to take this beyond the NFL. We have already made an announcement about Michael Waltrip Racing. It was in May for NASCAR. They use it both for practice and for pit crew, for evaluating pit crews and get more efficiency out of pit crews. We also have it on a ladies' soccer team in China, a hockey team in Russia. We have lots of conversations now with basically all major leagues to see how they can take advantage of our sports analytics packages. I think that there will be lots of other types of sports doing this and going after also the practice fields for the NFL.

And I would say one of the biggest themes that I hear when we talk to professional football leagues, particularly, is around how to get more people to attend the games. And when they do attend the games, then provide some enhanced value. So part of what we can do with our solution is that we can provide new experiences for people who are at the games, and we can also allow fans to engage with their teams in between games. So you can do fantasy football or other things that can be shared in a totally different way. So I think from a sports franchise perspective, this is a great way of really having a much closer relationship with their fans and help that to improve their franchises.

Operator (participant)

Once again, if you have a question, please press star one. Our next question comes from Michael Kim from Imperial Capital. Please go ahead.

Michael Kim (Managing Director in Investment Banking)

Hi. Good morning, guys. It sounded like there's a bit of a return in large deal activity. Just curious if you could comment if you see that continuing through the balance of the year? And also on the run rate business, if you see the channel inventory levels sort of normalize from sort of historical levels?

Michael Smiley (CFO)

So I'll start, and then I'll ask Mike Terzic to amplify a little bit here. First, on the channel inventory, it's very healthy today. There's no abnormalities, I guess, as you say, in our channel inventory. We feel it's at appropriate levels across the globe. Large deal activity has been and run rate business continues to do well. Our run rate business is strong, but it's the majority of our business. Large deal activity has obviously picked up quite nicely this year. It really started in the second half of last year and continued through the first half. And we see strong pipeline across the globe for the second half of this year. So we feel the business is in good shape, and we're competitively very well positioned also.

Mike Terzic (SVP, Global Sales and Marketing)

Michael, just a couple of other points on that. That is correct. I think the pipeline has increased in both value and volume in every geographic region that we serve, most notably North America and Europe, but we also have a very strong pipeline that has been evolving in Asia Pacific. Specifically, Asia more around manufacturing vertical and the T&L market has been very robust in Asia as it continues to expand. In Europe, it is nicely balanced. That pipeline has some opportunity in the retail space, in the T&L space, and in healthcare. And in North America, as we said earlier on the call, it's been driven by quite a bit of retail refresh, but also the T&L space has got some nice opportunities as well. So we're feeling at this stage in the year we're in really good shape.

To Anders' earlier point, run rate remains solid in all geographic regions, and inventory levels are in very good position.

Michael Kim (Managing Director in Investment Banking)

Okay. Great. And then just specifically on the Latin America region, can you remind us how important Brazil is as a country market? And if you see an opportunity to sort of turn that positive now that we're past the World Cup period?

Michael Smiley (CFO)

So Brazil is an important part of Latin America. Mexico is the largest country for us in Latin America, with Brazil being the second one. But I would say over the last several years, the Latin American market has become more diversified for us. We've seen great growth in countries like Colombia. It's been Chile, it's been another one. So other markets are growing faster than some of the largest markets, and that's been very nice to see. Brazil has always been a bit more volatile for us. Last year, we had a tougher comp. We had a large deal that didn't repeat itself in this quarter. And our belief is that the World Cup didn't help the business momentum in Brazil, but we still believe Brazil is a good market for us and that there's going to be a lot of demand for our products there.

Operator (participant)

Our next question comes from Andrew Spinola from Wells Fargo. Please go ahead.

Andrew Spinola (Analyst)

Thanks. Can I ask you to maybe drill down a little bit more on the synergies? Do you have a sense of maybe how the full $150 million you expect to be realized, sort of however you think about it, XYZ amount in 2015 and 2016, or just generally, does the $50 million come more front-end loaded or back-end loaded, the incremental $50 million? Thanks.

Michael Smiley (CFO)

Yeah. This is Mike Smiley. I don't think we have we're still working on exactly when that's going to fall out. We do think that there's a meaningful portion that comes in the first year, but maybe more towards the back half of the first year. But again, I think the big reason for the increase from 100 to 150 is again because of looking at our raw material costs. And then the other piece is the fact as we look through the activities that help us achieve the 150 outside the parts cost, we see the ability to do those a little sooner than we had expected. I will tell you, when we did the $100 million, that was our best estimate at that time.

So I think the 150 is a more studied view today, but it's a little bit premature to give you a better view as exactly when that's going to fall out year to year.

Andrew Spinola (Analyst)

Fair enough. Thanks. And then just on supplies, that business continues to do quite well. It sounds like the environment is generally pretty good in your end markets. Do you think that this business can continue to run at rates close above the corporate average, sort of around 10% maybe going forward?

Michael Smiley (CFO)

Yeah. We are very bullish on the supplies business. First, I would say it's a very, very large market, and we have a very small market share. In North America, we are the most penetrated, and it's been a high-growth market or business for us here. But if you look at markets like Asia-Pac and Latin America, we are just starting to work on healthcare products there. And we had had actually the strongest growth in the quarter for supplies was from Asia-Pac and Latin America. And another area which we think still has lots of growth opportunities for us for supplies is in healthcare or wristbanding and other labeling for healthcare.

Operator (participant)

Once again, that's star one for questions. And our next question comes from Keith Housum from North Coast Research. Please go ahead.

Keith Housum (Managing Director and Senior Equity Research Analyst)

Hey. This is a question for Mike Smiley. Sorry, just for a follow-up. Mike, can you just help us just kind of drill down for that $150 million synergies? Is that coming from the number that investors can back into off of Motorola's 10-K, or is that from the numbers that were provided with the April 15th 10-K when the deal was announced?

Michael Smiley (CFO)

Are you talking, Keith, about stranded cost?

Keith Housum (Managing Director and Senior Equity Research Analyst)

Yeah. Because there's a little bit of question about what exactly you guys are inheriting in terms of operating expenses and things of that nature as we try to back into the numbers and look at them. I think we look at two different scenarios. So I just want to understand what our starting point is.

Michael Smiley (CFO)

I guess, Keith, what I don't want to do, and I can't really tell you exactly the math that makes up the $100 million, that's something you'll have to ask MSI on. And so our numbers is basically looking at the starting point of what we see for 2013 and looking for what we see as an optimal organization going forward, as well as understanding opportunities in reducing the cost of our materials. So it's not really reconciled off of the $100 million that MSI gave us. And by the way, I think stranded cost is a definition which sometimes can give the idea that these are costs that are in our business and we're going over. But some of these costs were really never coming over and not sort of expected to be a burden to our P&L.

I think if you try to reconcile those two numbers, that may be difficult to do.

Keith Housum (Managing Director and Senior Equity Research Analyst)

Okay. I appreciate the commentary there. Then if I just come back to the core business, it sounds like in past quarters, you guys had a little more conversation was focused on the refresh cycle, where if I understood what you guys were saying from today's script, it's more driven by the penetration in the verticals that you play in. Is that a correct understanding, or do you think the mix or the volume growth is more equalized between both the refresh cycle and increased penetration?

Mike Terzic (SVP, Global Sales and Marketing)

Keith, this is Mike Terzic. I think you're correct. I think certainly in the past quarters, we talked to the point of the refresh cycle. From an experience perspective, we know that these cycles last. It's hard to say, hard to predict how long they run. Historically, they've run longer than the one we're in right now, but we also know that market dynamics have changed a little bit relative to some of the globalization and some of the competitive issues. So at this point, I would say that the balance in the quarterly performance shifted on us a little bit away from the run rate and a little bit more towards the deal opportunity, which is not uncommon.

If you look at the surge we've seen in Europe and the robust outlook we have in North America, we're enjoying the deal activity on top of the run rate, but we've seen a little moderation in the run rate.

Michael Smiley (CFO)

I would say also the refresh tends to or large deals are often refreshed, but not always refreshed. And we do penetrate more deeply into some of our existing accounts with large deals. And I would say this quarter, we had some very nice large deals in manufacturing in China going into local domestic Chinese manufacturers who bought our high-end Xi printers. So we still certainly continue to drive further penetration into all our verticals on a global basis, and that's a good it provides a good growth opportunity for us.

Operator (participant)

Our next question comes from Greg Halter from Great Lakes Review. Please go ahead.

Greg Halter (CFA)

Yes. Good morning and congrats on the excellent results.

Mike Terzic (SVP, Global Sales and Marketing)

Thank you.

Greg Halter (CFA)

Just wanted to see if I could get your thoughts on how your three large customers did in the quarter and what you're seeing going forward there.

Michael Smiley (CFO)

Yeah. This is Mike Smiley. I don't think we had huge changes in the top three. Keep in mind, those are all vendors, distributors, and so they're not really representative of sort of the three largest end customers. But we didn't see overall any major changes in those top three customers.

All right. And as I understand, the MSI piece works with them as well.

Yes.

Greg Halter (CFA)

One last one for you on the product innovation side, the Zatar integration with iBeacon. Just wondered if you could comment on how that's going. Thanks.

Michael Smiley (CFO)

Yeah. So Zatar, in general, we continue to be very excited about the opportunity that it offers. Our pipeline is growing, and we continue to work on expanding the functionality of Zatar. iBeacon is one application that we've seen a lot of interest around. It's primarily, I would say, two use cases. One is in retail where the iBeacon can be used to do locationing of shoppers in a store and help push couponing and other things to them. And we can do that with Zatar in different ways. You can either use your smartphone for this, which is how other iBeacon solutions work, or we can put it up on a more common screen, which is quite unique for what we can do.

We also see use cases for this in healthcare for, say, helping to direct somebody who comes in to a general inquiry desk and want to find radiology, and they can use the Beacon technology to guide them for how to walk through the maze of a hospital.

Operator (participant)

We have no further questions. I will now turn the call back over to Doug Fox for closing comments.

Douglas Fox (Head of Investor Relations)

Thank you, everybody, for joining us today. Just as a reminder, our next scheduled quarterly conference call will be on November 4th. So everybody, have a good day. Thank you.

Operator (participant)

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.