Good morning, and welcome to Zebra Technologies' third quarter 2015 earnings release conference call. Joining us from Zebra Technologies are Anders Gustafsson, Chief Executive Officer; Mike Smiley, Chief Financial Officer; Joe Heel, Senior Vice President, Global Sales; and Dean Lindroth, Vice President, Finance. 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. Dean Lindroth of Zebra Technologies. Sir, you may begin.
Thank you, and good morning for joining us today. Today's call will include prepared remarks from Anders Gustafsson and Mike Smiley. Joe Heel will join us for the Q&A portion of the call. A replay of this call will be available on our website approximately two hours after the conclusion of the call. Certain statements made on this call will relate to future events or circumstances, and therefore, be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as expect, believe, anticipate, and outlook 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. Information about risk factors that could impact our results is noted in the press release we issued this morning and is also described in Zebra's latest 10-K, which is on file with the SEC.
Finally, we will make references today to both GAAP and non-GAAP measures. You can find reconciliations of our GAAP to non-GAAP results in today's press release. In addition, year-over-year sales growth references for Enterprise and total Zebra will be on an estimated historical basis. Now, I'll turn over the call to Anders.
Thank you, Dean, and good morning, everyone. We recently celebrated the one-year anniversary of Zebra's acquisition of Motorola Solutions' Enterprise business. I have long believed that these two businesses would be better together, and today I am more convinced than ever. Before I discuss our results for the third quarter, I would like to review the strategic priorities that we set last year and our progress to date. These priorities are the foundation for Zebra's transformation and delivery of our value proposition. Our priorities include, first, growing the business, particularly in enterprise, through renewed focus, leveraging complementary strengths, capitalizing on cross-selling opportunities, and increasing our strategic importance to customers. Second, expanding our market opportunity by creating solutions to enable enterprise asset intelligence. Third, improving execution, particularly in the channel, service delivery, and customer experiences. Fourth, realizing cost synergies.
Finally, differentiating ourselves with our leadership in technology, channel relationships, partner ecosystem, and brand. Executing on these priorities will enable us to capitalize on the opportunities being created by the secular trends in mobility, the cloud, and the Internet of Things. The proliferation of connected devices, the explosion in mobile apps and e-commerce, as well as the expanding mobile workforce, are all generating exciting growth opportunities for Zebra and our partners. Other key growth drivers are technology advances, including the operating system migration in mobile computing and the data capture transition from 1D scanning to 2D imaging. One year into the merger, I am very pleased with our progress. We have returned Enterprise to growth, with sales through September up 6% year-over-year in constant currency.
Part of this achievement is the result of increasing our win rate against consumer devices in retail to nearly 80%, compared to 50% last year. Win rates in transportation and logistics and manufacturing are also higher. This was accomplished with an expanded portfolio of differentiated enterprise-grade devices that deliver a superior value proposition in our target market segments and use cases. We have improved enterprise execution in the channel, particularly in China, where we have begun to regain ground and have increased sales year-to-date by 60% compared to last year. With an early investment in Android, we have demonstrated a high level of success in the operating system migration in mobile computing by growing Android sales through September by 170% compared to last year. In the original Zebra business, we have grown sales year-to-date by 12% in constant currency, with double-digit increases in printing, supplies, and location solutions.
Finally, our growth is also attributable to a stronger, more recognizable Zebra brand and an unrivaled partner network. With these achievements, we have delivered a nine-month adjusted EBITDA margin of 16.3%. On a constant currency basis, this is nearly 20% compared to a 2013 pre-merger estimate of 15.6%. We have more work to do in areas that include launching our new channel program, growing services, expanding gross margin, and cross-selling. That said, our results underscore the potential of the strategies we are pursuing and the value of bringing together Zebra and the Enterprise business. They also demonstrate that we have accelerated Zebra's transformation into a globally diversified industry leader that is well-positioned for the opportunities ahead and to achieve our long-term financial targets. Now turning to our results for the third quarter. Sales were $919 million, excluding purchase accounting adjustments.
In constant currency, this represents 6% year-over-year growth, including enterprise growth of 5% and pre-transaction Zebra growth of 8%. Non-GAAP earnings per share were $1.39, up 71% from a year ago. From a sales perspective, we continued to grow in our three largest regions. Year-over-year growth in the quarter was 8% in North America, 3% in constant currency in EMEA, and 23% in Asia Pacific. Demand remains strongest in retail and transportation and logistics. Momentum in healthcare also continues to grow. Top growth drivers again included e-commerce, mobility, the OS transition, and the continuing refresh cycle in printing. In North America, mobile computing sales reflected strong demand for our Android product line, particularly in retail. From a new order perspective, wins in retail and manufacturing included several mid- to small-sized accounts, which came through the channel.
In data capture, growth was particularly strong in our OEM vertical, and we continued to see increasing momentum in the transition to 2D imaging. Printing growth was led by increases in sales of tabletop and desktop product lines. In EMEA, as we anticipated, growth in constant currency moderated from first half levels. This included a more typical summer slowdown in Europe, in contrast to the unusually strong summer last year. Momentum in mobile computing remained solid in Europe, particularly in the U.K. and Germany, where orders included new wins in manufacturing, retail, and government. Sales in Africa and the Middle East slowed due to the low price of oil impacting industrial customers. Sales in Russia and Turkey declined due to current geopolitical challenges. With respect to the April price increase on euro-priced products, demand does not appear to have been negatively impacted.
In the third quarter, the price increase gained traction, particularly in printing. Compared to the third quarter, we expect a sequentially higher benefit in the fourth quarter, resulting in an annualized benefit of $25 million-$30 million. In Asia Pacific, we continued to see solid growth across the region, particularly in China, India, and Southeast Asia. While manufacturing remains challenged, retail upgrades and e-commerce are driving strong growth in both mobile computing and scanning. Solid printer growth, particularly in desktop, continued in transportation and logistics and healthcare. Aftermarket sales were also up significantly as a result of our ongoing effort to address an underserved market. Sales in the Latin America region declined 16% as a result of a difficult macroeconomic environment. Currency devaluations and the decline in purchasing power have led to postponement or cancellation of opportunities across the region.
To position ourselves for a return to growth when the regional economies improve, we are using this opportunity to strengthen our go-to-market strategies. One of the contributors to our sales growth this year is the operating system migration in mobile computing. We believe that there are approximately 15 million units in the field with legacy operating systems. We expect that the majority will be replaced by the end of 2020 with devices featuring a modern operating system. Typically, with technology transitions, the largest customers lead away. Winning these early adopters is critical to establishing a beachhead and paving the path for future growth and profitability. These large accounts are strategic, profitable, and drive significant levels of business. Some, due to their scale, yield a lower than average initial gross margin. Over time, margins in these accounts improve as we reduce product costs and cross-sell other higher margin products and services.
Most importantly, these accounts provide key reference points in the marketplace, which are necessary for broad-based technology acceptance. This in turn expands partner support and fosters adoption by mid-sized and run rate channel customers, which generally yield a higher than average margin. In our mature Windows device business, for example, our highest margins come from mid-sized deals and run rate business, which represents over 80% of Windows-based sales. Currently in Android, large customers are leading the OS transition. Sales from mid-sized customers and run rate business represents only 40% of Android sales. As we grow our Android business and shift the sales mix toward the Windows sales mix, we expect the gross margin across our Android portfolio to improve. Other margin improvement plans include product redesign and supply cost reductions.
In addition, our synergy program will have a more meaningful impact on product costs next year, including further reductions in material, freight, and overhead costs. I am pleased with our results in the quarter and year to date. We are executing on our strategies and capitalizing on the opportunities in the marketplace. We remain confident that we will achieve further success through consistent execution and satisfying our partners and customers with technology to enable the smart, connected enterprise. I will now turn the call over to Michael Smiley to provide more details on our financial results and the outlook for the fourth quarter.
Thank you, Anders. Total GAAP sales for the company were $916 million. Enterprise sales, which exclude the impact of purchase accounting, were $605 million, up 5% on a constant currency basis, primarily due to strong growth in mobile computing and data capture products. Sales of wireless LAN and services declined from a year ago. Pre-transaction Zebra sales were up $314 million, up 8% in constant currency, with solid growth in printing, supplies, and location solutions. GAAP margins for the quarter were 45.2%. Excluding the impact of purchase accounting, gross margin was 45.5%, up slightly from our adjusted second quarter gross margin of 45.3% and consistent with our guidance. Enterprise gross margin was 42.5% compared to the second quarter-adjusted margin of 42.8%. Sequentially, margins reflected product cost and warranty expense reductions, some of which were one time in nature, and our European price increase.
This was offset by increased excess and obsolescence reserves on various product and service parts inventory, primarily also one time in nature. Pre-transaction Zebra gross margin was 51.2% compared to 50% in the third quarter of last year. Compared to a year ago, the impact of currency has been offset by lower product costs in hardware and supplies, the price increase in Europe, and the benefits of our hedging program. Margins were also up sequentially due to higher pricing in Europe and lower product costs. Operating expenses for sales and marketing, R&D, and G&A were $288 million, including approximately $8 million of stock-based compensation expense. Expenses declined from the second quarter due to the timing of expenses for market development programs and non-integration related IT projects. G&A costs declined due to lower than anticipated employee-related benefits costs.
Other operating expenses included acquisition and integration and exit and restructuring costs of $43 million and amortization of intangible assets of $58 million. In the quarter, the net loss per share on a GAAP basis was $0.57. Non-GAAP earnings per share were $1.39, compared to $0.81 in the third quarter of last year. Adjusted EBITDA was $159 million, or 17.3% of sales, up from 14.7% in the second quarter. Turning now to cash. Free cash flow in the quarter was $58 million, and we ended the quarter with $258 million in cash. This includes $170 million outside the U.S. Subsequent to the end of the quarter, we made $65 million in scheduled interest payments and a $20 million principal payment in our term loan. This brings the total principal payments this year to $150 million. Our current net debt to adjusted EBITDA ratio is 4.8 times.
Through nine months, cash flow has been impacted by significant expenditures associated with the Enterprise transaction. This includes non-recurring expenditures of $51 million in working capital settlement payments to Motorola Solutions and $32 million in real estate expenditures, primarily related to the building out of a leased facility to accommodate our Illinois-based employees. With these expenditures behind us, growth in the business, and working capital management, we expect a significant increase in cash flow generation next year. With this improvement, we anticipate additional debt reduction next year of $300 million or more. Before moving on to guidance, I want to provide an update on our synergy program and overall cost structure. We target a synergy opportunity of $150 million associated with the integration of the two businesses, with the ultimate objective of achieving an adjusted EBITDA margin of 18%-20% by the end of 2017.
We have pursued this synergy opportunity while we restructure and staff the organization and grow the business. Compared to the pre-merger 2013 baseline we established, we will realize this year approximately $120 million of operating expense synergy benefit from actions implemented in 2014 and 2015, and costs not transferred from Motorola Solutions. This includes $60 million in sales and marketing and $25 million in engineering, primarily result of staff reductions. We will also incur this year approximately $30 million of incremental operating expenses associated with the transaction. These include resource inefficiencies of operating in two separate IT systems, filling critical positions not transferred from MSI that are necessary to support the business, and support and advisory costs, particularly in finance.
Finally, the business continues to grow, requiring the appropriate level of reinvestment as well as compensation-related cost increases such as merit and incentive pay, totaling $16 million compared to the baseline in 2013. In aggregate, we expect an absolute reduction in operating expenses this year of approximately $30 million, or 3% compared to 2013 levels. Constant currency sales growth over the same period is approximately 10%. Measured a percent of sales, operating expenses will decline this year to 32%, compared to a currency-adjusted 36% in our baseline year, a 400 basis point improvement in our cost structure. Finally, on a run rate basis, the operating expense synergies I've mentioned, combined with $50 million of targeted cost of goods sold reductions, result in approximately $200 million of total gross run rate synergy benefits by the end of next year, compared to our goal of $150 million.
Looking ahead with some potential for further operating cost savings prior to completing our IT integration, balanced with investment to grow the business, we plan to tightly manage net growth in our operating expenses. This is expected to result in further operating expense leverage in the range of 200-250 basis points over the next two years. With respect to our fourth quarter outlook, our guidance reflects the recent further reduction in the U.S. dollar against the euro. We expect continued growth in the business, resulting in sales of $945 million-$975 million. This represents year-over-year growth of 3.6%-6.9% on a constant currency basis. Non-GAAP earnings per share are expected to be in the range of $1.38-$1.63, and adjusted EBITDA in the range of $155 million-$170 million. We expect gross margin in the range of 44.5%-45.5%.
On a sequential basis, we anticipate increased benefits from European price increase and cost reduction, offset by the impact of a large mobile computing deal. Operating expenses for sales, marketing, R&D, and G&A are expected to be in the range of $293 million-$298 million, including stock-based compensation expense of $8 million. The increase from the third quarter is primarily related to typically higher fourth quarter expenses for marketing programs, sales commissions, and employee benefit costs. IT costs will also be higher as we begin to implement and support parallel business applications in preparation for certain TSA exits. We expect interest expense of $48 million-$50 million, and a non-GAAP tax rate in the range of 22%-24%.
Compared to the third quarter currency environment, the impact of the recent strengthening of the US dollar against the EUR has reduced the high and low end of these ranges by approximately $6 million on sales and $5 million on adjusted EBITDA, 30 basis points on gross margin percentage and $0.05 per share on non-GAAP EPS. I will now turn the time back to Anders.
Thank you, Mike. In addition to satisfying customers, introducing new products, and pursuing new opportunities, we have been hard at work integrating the company. Since the closing in October of last year, the integration program has progressed well, with accomplishments in organizational design and culture development, real estate consolidation, implementation of tools for our sales team, engineering system migrations, and a global brand transition. This work includes the elimination of over 250 enterprise IT applications, closure of over 200 Motorola transition service agreement items, and exits of over 20 real estate sites. The team has accomplished a lot in the past year, but we have more to do. Future integration efforts will primarily focus on the implementation of the IT infrastructure and business systems and enable us to conclude all remaining support services from Motorola Solutions.
In doing so, we will modernize and right-size our business processes and ecosystem by transitioning enterprise onto new or upgraded Zebra systems. The result will be a more efficient and cost-effective IT architecture and ecosystem of applications, lower operating costs, and lower ongoing capital expenditure requirements. Further progress in our efforts will be marked by several milestones next year. In the first quarter, we will complete several additional engineering system consolidations. A phased implementation of systems for our services business and our integrated ERP will start in the second quarter. Systems supporting our new channel program will also begin to roll out in the second quarter. In the third quarter, we will launch our distribution center consolidation initiative with the outsourcing of our North America printing operation to a third-party logistics provider.
We expect to complete the systems migration and be entirely off Motorola-supported IT systems before the end of 2017. The remaining costs to complete the overall integration program, including capital expenditures, are expected to be approximately $180 million-$200 million through 2017. Looking ahead, our strategies remain anchored in capturing growth, improving execution, and differentiating ourselves. Our top-line results demonstrate that customers are increasingly turning to our technology to gain a competitive advantage, reduce costs, and improve productivity in an expanding array of applications, including e-commerce, omni-channel, workforce mobility and workflow, and delivery of real-time actionable data. Solid execution is improving customer experiences and performance in the channel. We are differentiating ourselves with innovative products, deep channel relationships, and a global ecosystem of more than 10,000 partners. A highly trusted brand.
Our progress this year, along with secular growth drivers and Zebra's differentiators, underpin our confidence in achieving long-term sales growth of at least 4%-5% over a cycle. With the strength of our mobile computing portfolio, we believe that we can exceed that range if the pace of the operating system migration in mobile computing accelerates. As we grow the business, we continue to expect adjusted EBITDA margin expansion to 18%-20% by the end of 2017, assuming a currency environment consistent with the third quarter. Over the next two years, we expect to achieve our adjusted EBITDA margin target with gross margin improvement in the range of 50 to 100 basis points as we introduce more innovative products, reduce product costs and services costs, and grow our Android mobile computing sales, particularly through the channel.
In addition, we expect further cash operating expense leverage in the range of 200 to 250 basis points as we manage our cost structure and realize the efficiency benefits of our IT migration. The increased cash flow generation from margin expansion and other actions will enable us to further reduce debt by at least $650 million and reach net debt to adjusted EBITDA ratio of less than three times by the end of 2017. In closing, Zebra has a history of consistent execution, and we intend to extend that track record by capitalizing on the opportunities ahead and delivering on the targets that we have set. Thank you for your continued support of Zebra. Now, I would like to turn the call back to Dean for Q&A.
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. Operator, can you provide our callers with instructions on how to ask a question?
Thank you. 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 Keith Housum from Northcoast Research. Please go ahead.
Good morning, gentlemen. Thanks for taking my question. Question for you guys on the gross margins. If I can just hone in on the enterprise margins. If I understood that correctly, the enterprise margins were 42.5% versus 42.8% last quarter. I guess, Anders and Mike, how does that compare to, I guess, historical averages for enterprise margins? Then if you could just drill down a little bit more on the one-time items, like the obsolescence write-off you guys took and how that may have impacted it this quarter?
Keith, it's Mike. I think a couple things on the one-time items. First of all, the excess and obsolescence, a lot of that was related to services, wasn't so much on mobile computing. We had, within the mobile computing, a number of sort of beneficial things, one-time things going both ways. Net-net, it really didn't have a big impact on our gross margin. Some of the E&O was related to enterprise mobile computers offset by, as we'd talked about before, working with our suppliers and vendors to reduce some of our product costs one-off. When you look at it, there wasn't a big net-net benefit or change in our gross margin for the enterprise mobile computers.
How does this compare to historical cycles that you guys are in when you guys are launching new products? Is this historically average or is it a little bit below average?
Actually, as you look at this, I think obviously the Android is the new product area you're focused on. As we look at the large deals that we're getting for Android products, they're very similar to the large deals we'd win in Windows. We're really encouraged that to build that market share, we're doing it at very consistent margins that we had before. However, as the business grows in Android, as Anders mentioned, we will expect to see more channel or run rate business, which will come at a higher margin going forward. Also encouraging is the fact that as we continue to develop those products at a lower cost point, we would expect margins to continue to be favorable.
The 42.5 that you get compared to historically three, four, five years ago, is that historically average, or how does that compare to historical numbers?
I think if you normalize that for FX, we would expect that to be very similar to what we've seen before.
Okay.
Maybe to reiterate one point Mike said, which I think may have been misunderstood by the markets maybe, is that if you look at the margins we get on our large Windows-based deals, it is very consistent with the margins we get on our large Android deals. There's no difference really in the price points and margins on large deals, either Android or Microsoft.
the other thing, just to go back to FX, if you look at our EBITDA margin, FX adjusted, we would've been 20% EBITDA margin for the quarter. FX is a very meaningful impact on our profitability.
Okay. Appreciate that.
If I could ask one more. Mike, you went through the synergies really quick, I guess in a nutshell, should we think of synergies, you guys actually increased your guidance for operating synergies from $150 million to $200 million?
Over a three-year period, yes. I think a couple things that happens, sources of that are, as we talked about some of the dyssynergies associated with the transaction that we're incurring, we expect that to moderate substantially. We expect the IT systems to allow us to be more efficient as we go forward. There's a number of things that we would expect over a three-year period to help us to go from $120 we've already realized eventually to $200 over the next several years.
We'll take our next question, please.
Our next question comes from Holden Lewis from Oppenheimer. Please go ahead.
Great. Thank you. Good afternoon, or good morning. On that synergy question, I guess the $120 that you're talking about, what are you expecting to actually sort of realize in 2015? What's sort of the incremental that you expect to realize in 2016? How is the sort of the incremental realized dollars playing out at this point going forward?
I think one of the neat things about our business is the top line is growing. Effectively, on a constant currency basis, our revenue has grown by 10% since 2013, yet our operating expenses net have gone down by 3%. Basically that's 13%, what I would call operating leverage. When you try to determine, or as far as how that net happens, you have $120 million of realized synergy in our P&L in 2015 for the full year, which is big buckets again, our R&D and sales and marketing. Then we have cost increases of roughly $30 million, which is associated with, again, the inefficiencies of putting the two businesses together, ERP, that related stuff, offset by what you would expect is normal OpEx growth as the business grows by 10% on a constant currency basis.
Net, we're $30 million lower in OpEx 2015 to 2013. Again, with the plans we have going forward, we still expect to hit the 18%-20% EBITDA margin reflecting exchange rates we saw in the third quarter.
Okay. Then with respect to, it looks like the core Zebra business is somewhat slower. I know that your revenues were in line with sort of the guide, sort of the first time in the last couple of quarters that you didn't come in at the high end, I guess. Does that reflect a little bit of weakening in the market? If it does, can you talk about what triggers you may have to pull related to the acquisition and integration, where if the macro does slow, you can perhaps mitigate it with some specific initiatives that could offset? How do I think about your ability to perform at the top line in maybe a weakening macro environment?
First, we had, I think, signaled all along that the very strong growth rates we had on the printing side in the first half would start to moderate a bit based on kind of lapping ourselves, having very strong growth rates, in the second half of 2014. I think the growth rates were actually very solid, I thought, in Q3. The only one that kind of stood out in that case, quarter-over-quarter would be the European one. Europe tends to have, historically has had a slight decline in Q3 as good chunk of Europe goes on vacation. Last year, we did not see that. We actually had a very strong quarter. We had growth in that piece. We feel good about where we are. We have been able to gain quite a lot of market share over the last couple of years.
With our portfolio, with our sales team and the support of our channel partners, we do believe that we should be able to continue to gain share and grow faster in the market. I'll let Joachim Heel here also make some comments.
This is Joe. I'll add specifically to your question about initiatives and levers that we have to continue to drive growth. On top of what Anders said, I would point specifically to the operating systems migration. This is an area where we do have targeted initiatives underway. The install base is an area that we are very actively and very systematically pursuing. The second one is the transition from 1D to 2D in scanning. Also, an area where we're very actively taking the opportunity to systematically go through install base and take share.
Okay. Thank you.
Next question, please.
Our next question comes from Andrew Spinola from Wells Fargo. Please go ahead.
Just looking at your operating expense commentary off the base of 2015 instead of 2013, did I hear it correctly that, Mike, you think that expenses will grow but at a slower pace essentially than revenue in 2016 and 2017? Is that the right way to think about it?
Absolutely. What we're looking to do is manage our operating leverage. We expect to see some nice improvement as our top line grows. Our OpEx will grow substantially lower. When you net it out, we see a 200 to 250 basis point improvement between now and end of 2017 to get us to the 18% to 20% EBITDA margin.
Understood. Just a clarification, I think, Anders, you made the comment that there's another $180 million to $200 million of integration and acquisition spend between now and 2017. Did I catch that correctly?
That's correct. That includes then all the IT spend, including CapEx also. We also said that that would help yield substantial efficiencies past the 2017 date. As we get into 2018 and so, we expect to drive further operating leverage based on those investments.
Understood. Just stepping back from my perspective, it does seem like I'm a little surprised the acquisition and integration spend was the highest this year in the third quarter. I guess I would have thought it'd be stepping down. The fact that there's another $180-$200 sounds like a good bit more than I was looking for. I'm just wondering, did it turn out that there's more opportunities for things that you could optimize? Maybe on the flip side, it turned out that Motorola needed more investment than was initially expected.
First, we're very pleased with the efforts to date on integration. We feel that the integration has gone very well for us. If you look at things like how we designed and integrated a new sales organization, I think that was done very well. There we had basically a blank sheet of paper that we started with, we didn't really merge the organizations, it was very stressful as we went through it. Looking back, I think we very quickly got the right team, knowing their roles and be out focusing on selling. We've done a lot of work around culture. We feel that culture is one thing that can derail an acquisition like this. We've had 250 of our most senior people come together in various workshops to work on how to create a common culture across the entire organization.
I'd say the organization has responded really well to all of those things. On the negative side, I'd say the complexity of the IT systems has been greater than we had expected. Motorola had a bit of a patchwork of systems, a lot of customization. They didn't necessarily all talk to each other. As we pull this together, we're looking to see how we can create a platform that's across all of Zebra to drive the right level of efficiencies to then continue to generate great synergy, operating leverage benefits after we're done with this.
As far as the third quarter, up until the third quarter, a lot of the energy on the IT integration stuff was really on planning. We're starting to put a lot more resources and actually executing on those plans. That's, I think, a little bit of impact on the timing of the cash flows for that work.
All right. All makes sense. I was just curious. Thank you very much.
You're welcome.
Next question, please.
Our next question comes from Brian Drab from William Blair. Please go ahead.
Hi, good morning. Congratulations on the solid result.
Thank you.
Okay. First question. I just want to make sure that I have this clear. Is the expected restructuring savings amount now $200 million by the end of 2018?
'17.
'17.
This, yeah.
Yeah, run rate again. I'm sorry, run rate.
'17.
By the end of 2017?
Yes. The run rate as we exit 2017 will be that, so you should realize it in 2018.
Got it. Okay, thanks. The $30 million in expenses, the incremental expenses, that's an offset to that $200 million, or is that $200 million number a net figure?
The $30 million we're talking about is if you look at 2013 versus 2015. Now, 2015, we realized-
I don't know if it's just me, but it's very hard to hear Mike, if that's Mike.
Sorry about that. The $30 million is in relation to 2013 versus 2015. Again, we had $120 million we realized in 2015, in our P&L. We had $30 million in 2015 with cost increases associated with the transaction, an additional normal expense growth of $60 million. That $30 million we would expect to decline over the next year or so, because obviously some of the work associated with the integration will go away. For example, some tax stuff, consulting and such. The $30 million will go down, which is in part one of the reasons why we have some of the synergies we expect to achieve as we go forward.
Okay. Thanks. Some of the $30 million stays, a significant portion of that will go away.
Yes, over time.
Okay. Can you just break down your sales? I don't know if you can just do this roughly maybe, but in a couple different ways. I'm curious about the % of sales in the third quarter that was associated with large deals, also, if you could give us any sense, % of large deals that have been Android versus Windows in the third quarter.
I'll start, and I'll hand over to Joe. Generally, we can't really share with you all that detail. Large deal is not a new phenomenon for us. We've had large deals forever. As I mentioned before, the margins on large Windows-based deals is very much in line with the margins on large Android-based deals. The pipeline for large deals is healthy and growing. We certainly hope to have some more things to announce in the next couple of months. We're also spending a lot of effort trying to make sure that we get Android into the channel, and we get the channel business to really pick up as much as possible so we can get the run rate of high margin deals there.
Perhaps the only thing I would add, just to emphasize what Anders said, large deals with large customers are nothing new and different. What's happening here is this continuity of operating systems is creating an opportunity for us to take share. I think that's what we've been very successful at in the last year, and we see an opportunity to continue to do that as this migration cycle continues, and the large deals will be the most prominent ones where this manifests itself.
Our next question comes from James Faucette from Morgan Stanley. Please go ahead.
Thank you very much. I had a couple of follow-up questions. First, in terms of the European performance in the quarter, you indicated that it was kind of a difficult comparison, or at least last year you saw growth, whereas this year there was more normal seasonality. I'm just wondering if you have any sense for how much price changes in that market may have impacted the demand there, and getting a sense for your view of price elasticity there. Also, if the currency remains weak there or were to weaken further, do you think that you'd be moved to make additional pricing adjustments? At what point are you able, or will you be unable to make continued pricing adjustments there based on competitors? My last question was kind of a follow-up to the previous question just on large deals.
At the time that the large deals were announced last quarter, you talked about follow-on sales and the like, and I would imagine those probably take time. I'm just wondering if we're getting any incremental indications of follow-on deals, either of people trying to emulate product or emulate solutions that were put in place, or that those customers themselves are preparing to come back and buy. Thank you very much.
Just quickly, what was the first one again? Just to make sure I answer the right ones in the right order.
Sorry. Yeah. Just asking if the pricing changes in Europe exacerbated any seasonality in that market.
Yes. To the best of our analysis, we don't believe that the price increases had any negative impact on volume. We don't think that we lost business because of that. If there was one possible thing, that would be that some of our partners stacked up a bit more in Q2, and it took them a little longer to burn off that inventory. Bought stuff before the price increase, basically, and it took a little longer to burn that off. Now we've started to see good improvement in margin based on this, and we said that from Q4 now, where we think we are basically gone through all the possible changes from Q2, we expect to see an annualized margin benefit of $25 million-$30 million based on that price increase.
You also asked, I think, next question about what happens if foreign exchange continues to deteriorate, and it's obviously hard to answer that in an abstract, because we raised our prices in May or April by 12%, that was also done in conjecture with many of our competitors. Many other technology companies did something similar. I think it's hard for us to, by ourselves, go out and do something like this, we obviously keep all our tools available for us, and we have the ability to raise prices more. We also have the ability to be more restrictive with price concessions and other things to make sure that the price points are higher. A lot of our large deals don't go through the channel, so they are bid on an individual basis.
When we bid them, we always look at the gross margin and the profitability of that overall deal. There we have a very immediate impact or ability to impact margins, even in a deteriorating FX environment. Maybe, Joe, you have any more comments on that?
Yeah. Just to follow up on that, James.
Sorry, I think once again, somebody's mic is off.
Yes, I'm sorry. That was mine. On the third point, the question was whether the large deals are beginning to lead to follow-on sales in the medium and small category, if I understood it correctly. Indeed, we are beginning to see this on the Android side in particular. If I look back to the beginning of this year, we could say that the vast majority of the deals, if not all of them, were ones where our direct sales force was driving and leading the sale. They were all large in nature.
As we now come towards the end of this year, we're seeing a much more significant portion of deals come without much of our intervention from the channel, and the mix is including now a large proportion of these medium and small-sized deals, which we think is healthy and beneficial the way that such migrations typically evolve.
Yeah. Maybe one example of one large deal that we won for mobile computing. Some other products and services that we have been able to sell to them now include wearable devices, which are very high margin. A lot more services, which we also have a very sticky and are with us for a long time. We also now understand that they have started to offer some of their customers Zebra printers, which they didn't do before. We're in talking to them about other more longer range, newer type of solutions. Clearly, we're now gone from being somebody who was on the outside, had a chance maybe to bid on an RFQ at times, to somebody they think of as a trusted advisor, a technology partner, and come to us to seek our thoughts and opinions about how we can best help them develop their technology portfolio.
Great. Thanks.
Next question please.
Our next question comes from Paul Coster from J.P. Morgan. Please go ahead.
Thanks. This is Paul Chong on for Paul Coster. Thanks for taking my question. For the 80% win rate in retail, can you elaborate on the drivers behind these wins besides the migration of the operating systems?
These were specific to wins against consumer devices. In prior calls, we've had some concern by investors that consumer devices are going to encroach on our space. I think it's fair to say that back in 2011, 2012 or so, when consumer devices first appeared on our radar screen, we were caught maybe a little flat-footed. We didn't really have any devices that could compete with them. Now we have a very compelling portfolio of new devices that have all touchscreens. They're ruggedized, but they have modern operating systems, so they feel much more like traditional phones, and our customers users are able to much more quickly get comfortable and use those. They are purpose-built for the use cases of our customers. With those devices, we now have something where we can compete, and we're winning probably more than our fair share of those devices.
It's really driven by new innovative products that we've been able to launch.
I would add, Joachim Heel speaking again, that over the last roughly three years, there have been many customers who have tried and experimented with consumer devices in the applications, in the enterprise. As they have made their experiences, we have been able to now win a lot of these deals based on the enterprise-grade features of our devices, in addition to the adaptation of the form factor that Anders mentioned and the functionality. Things like battery life, stability of operating system, ruggedness, are key factors that are helping us to win these deals.
Okay, thanks. What kind of visibility do you have with large deals in the pipeline in the next six to 12 months?
Joachim Heel again. We are very confident about our ability to continue to drive large deals, and also to supplement them with the medium and small-sized deals, so to really build out a pipeline that is very balanced. We feel strong about the large deals as well.
I don't know if you mentioned it or, what was your 2015 CapEx guidance, and are you giving guidance for 2016 at that time?
Yeah, we're not giving guidance for 2016 at this point. The CapEx for 2015, I would expect the fourth quarter to be a little bit softer than the third quarter, but not dramatically different.
Okay, thanks, guys.
Our next question comes from Matthew Gall from Barrington Research. Please go ahead.
Good morning. Thank you for taking my questions. A lot of the topics that have been asked, I can review, as far as the OpEx synergies and things like that, follow up. Maybe just from a broader scale, there's been some new product launch announcements recently, and you're expressing some larger mobile computing deals that are in the pipeline. If you could just touch on maybe some of the new product launches, like the ET50, ET55 tablets, where you're seeing some success there. Then as we look out, kind of a cadence of new product launches, both within mobile computing, and then along maybe some of the other data capture printing lines as well for hardware.
Yes, I'll start on the tablet side here. We won't talk about new products that we haven't launched yet because we want to do that properly in the market. On the tablet side, we see a lot of our customers use tablets in different form factors. We felt that there was an opportunity for us to have a bigger presence than we had before. It's one where we feel that having that broader portfolio will also position us better to be able to win the entire fleet of products that they have. Early indications from the launch, which is only about a month back now, I think, has been very positive. I'm not sure we have any big announcements to make quite yet, but we feel good about where we are after a month.
Yeah.
Joe has some further comments here.
Yeah, we have some very nice deals that are coming together on our new ET50 and ET55 tablets. We're excited about this product from two perspectives. On the one hand, this is the one area where consumer products had made some inroads, and we didn't have a product to properly counter them, which we now have. Our customers have been very eager to have a product that meets those same enterprise-grade specifications that we have on our handheld devices, that we can now bring to the tablet market. We feel that, both from an offensive and defensive perspective, this is really a terrific product for us to have in the market. We have some early successes that we're quite proud of.
All right. Great. Thanks for providing more color on that. Then, I know you maybe touched on the opening remarks, but as far as the rebranding efforts, where along are you on that? Is it moving as expected? As far as any of the costs associated with that, is there a guideline as to maybe when that should flow through the P&L, and we should see those rebranding costs be removed from the P&L?
At the end of this year, we expect that the majority of the rebranding should be done. There's a long tail, though, so they will continue to stay with us for 2016. From an intensity of the effort, 2015 is really where most of these things happen. For Q4, I think we have a bit more rebranding expense in our forecast than we had in Q3. That's one kind of miscellaneous item that's hitting the Q4 gross margin that we saw less of in Q3.
Yeah, to Anders' point, it's not a huge number.
Yeah
for the fourth quarter, it is a little bit of a headwind.
Okay. Thank you very much, guys.
We'll take the next question, please.
Once again, if you do have a question, press *1. Our next question comes from Jason Rodgers from Great Lakes Review. Please go ahead.
Good morning.
Good morning.
Just to follow up on the large mobile deals, I wondered if you were seeing any change in competition when you compete against those deals, if you're seeing other companies introduce more Android-based devices. As well as if the pricing on these large deals has changed, if you've actually walked away from any just because the pricing didn't make sense. Thanks.
Yeah, first, the competition for these large deals is, by and large, the same as for mid-size deals. The competition is probably more determined based on the vertical. If you're competing in retail versus manufacturing, you probably have some more differences there. We tend to see our traditional competitors, but we also see some consumer-grade competitors as well, and some lower priced or lower quality competitors from Asia, China, and Korea particularly. It's largely the same group of people. I think we have a pretty good understanding of their offerings and how to compete against them. We feel we are certainly holding our own, and I would say this year we've been gaining share in new wins, both on the larger deals and the more normal run rate business. The pricing environment seems to be consistent with what we've seen historically.
As we mentioned on the call, the margins we see on large deals for Windows-based devices is actually the same as the margin we see on large deals for Android devices also. I don't think that we see a big difference in that area. Joe, any further comments?
No.
Thank you.
We do have a follow-up question from Holden Lewis from Oppenheimer. Please go ahead.
Thank you. On the pricing, just so I understand, you said that the impact of pricing could be $25 million-$30 million. Is that the sales impact? Is that a profit impact? What number is that?
If we raise the prices by $25 million-$30 million annualized, there's no cost associated with that. Basically, you get the revenue, but it flows straight through to the bottom line.
Okay. If that is an annualized full-year number, can you tell me how much you're realizing in Q3 and for full year 2015, so we have a sense of what the incremental impact will be next year?
Yeah. I think we expect that we will be basically in the run rate now for this in Q4. You can take basically a quarter of that for the fourth quarter.
Okay. You don't think that you realized much of that in Q3 at all?
We did realize some of that in Q3. Not the full run rate, but we realized some of that.
Okay, $7 million, give or take, in Q4 and some smaller number than that in Q3, and then the rest will be realized incrementally next year.
That's correct. That's how we think about it.
Okay, great. Thank you.
Thank you.
We have no further questions. I will now turn the call back over to Dean Lindroth for closing comments.
All right. Thank you. Thank you everyone for joining us today. That concludes our call.
Thank you, ladies and gentlemen. This concludes today's call.