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Zebra Technologies Corp. (NASDAQ:ZBRA)

Q3 2007 Earnings Call

October 22, 2007 11:00 am ET

Executives

Charles Whitchurch - CFO

Anders Gustafsson - CEO

Mike Terzich - SVP, Global Sales and Marketing, Specialty Printer Solutions

Analysts

Phil Alling - Bear Stearns

Ajit Pai - Thomas Weisel Partners

Jeff Rosenberg - William Blair

Chris Quilty - Raymond James

Greg Halter - Great Lakes Review

Reik Read - Robert W. Baird

Andrew Abrams - Avian Securities

Jeremy Grant - Stanford Group

Kevin Starke - Weeden & Company

Operator

Good morning, and welcome to the Zebra Technologies Third Quarter Earnings Release Conference Call. Joining us from Zebra Technologies are Mr. Charles Whitchurch, CFO and Mr. Anders Gustafsson, CEO of Zebra Technologies. 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 questions. At the request of Zebra Technologies, this conference call is being tape- recorded. Should anyone have any objections, please disconnect at this time.

At this time, I would like to introduce Mr. Charles Whitchurch, CFO of Zebra Technologies. Sir, you may begin.

Charles Whitchurch

Good morning, and thank you for joining us today. Certain statements we will make on this call will relate to future events or circumstances, and therefore, will be forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Words such as "expect", "believe" and "anticipate" are few examples of the words identified in a forward-looking statement.

Forward-looking information is subject to various risks and uncertainties, which could significantly affect expected results. Risk factors were also noted in the news release we issued this morning, and are also described in Zebra's 10-K for the year ended December 31, 2006, which is on file with the SEC.

Now, let me turn the call over to Anders Gustafsson for some brief opening remarks.

Anders Gustafsson

Thanks Randy, and good morning everyone. I am very pleased to be here today to review Zebra's third quarter results. I have asked the Mike Terzich to join Randy and me on the call today. Mike leads Global Sales and Marketing for our Specialty Printing Solutions business unit.

Record sales and improvements in gross profit margin drove profitability higher, putting Zebra's third quarter results at the upper end of our forecasted range.

We had continued strength through channels and high growth in our international regions, coordinated good sales execution combined with a solid opportunity pipeline, which resulted in key wins in targeted vertical markets. These results are evidence that Zebra continues to be the winning brand in our core specialty printing business, and they demonstrate the success of our growth strategy.

During the quarter, we further positioned Zebra for accelerated growth with the acquisition of proveo, and an agreement to acquire Navis, which we announced last week.

These companies built on our platform in real-time location systems, which we established through the acquisition of WhereNet in January.

These three companies expand a range of data acquisition, technologies and solutions. Zebra is able to deliver two current and potential customers to identify, locate and track valued assets across the supply chain.

During my first month at Zebra, we have worked diligently to further identify and develop the various growth areas available to the company. The activities we have undertaken in our established businesses to sustain more consistent sales growth and profitability, combined with our investments in higher growth adjacencies, positioned Zebra for increased success going through the fourth quarter and 2008.

Let me now cover some of the third quarter highlights. In EMEA, sales bounced back from lower growth in the second quarter. Nearly all nine sub-regions made meaningful contributions to the turnaround.

Sales growth was particularly robust in Central and Eastern Europe, Italy, the Middle East and India. The strong backlog going into the second half of the year generated a consistent healthy rate of business throughout the quarter, with project wins in retail and warehousing among other verticals. The outlook for EMEA continues to be favorable.

Sales growth in Latin America accelerated, with solid performance across nearly all printer product lines and all geographies. Consistent with our second quarter experience, adoption rates of Zebra's mobile route accounting solutions remained high.

Asia-Pacific continued to stand out as an important contributor to overall growth. Greater penetration of large multinational accounts plus strategic wins in government, retail and healthcare, all are results of our investments over the past few years to strengthen our leadership, infrastructure and people in this region. We will focus on this, and a greater presence gives us optimism for further growth in the Asia-Pacific region.

Growth in North America improved over the second quarter, to deliver record quarterly revenues. Sales benefited from favorable business activity in several verticals. We also captured all the sales deferred by retailers in the second quarter. Relatively unchanged from the second quarter, activity with retailers is up for the year, thanks to our efforts to diversify and broaden our customer base.

Sales from WhereNet also made a contribution to consolidated North American sales growth. Overall, we made considerable progress in securing higher sales growth and greater profitability for Zebra during the third quarter.

High sales growth in international regions demonstrates the success of our geographic expansion programs. Higher gross profit margin was resulted from focused efforts to improve operational efficiency and reduce product cost. And our acquisitions demonstrate a strategic intent to deploy capital in related high growth businesses.

Now I'll turn it back to Randy to provide a detailed review of third quarter results and guidance for the fourth quarter of 2007.

Charles Whitchurch

Thanks, Anders, and good morning everyone. Well, I guess you'd have to say we're really pleased with the quarterly results for Zebra.

16.5% growth for the sales of the upper end of our forecasted range, while acquired company certainly contributed to this growth, our core business showed excellent strength with double-digit growth in the quarter.

Hardware sales accelerated by 16.9% from 12.6% last quarter, along with an improved product mix.

Average unit prices for the quarter were $585, which was down from $621 last year, but up from last quarter's $573.

New printer products accounted for 5.1% of third quarter printer sales. While we're clearly disappointed with this result, we expect this number to improve significantly in the fourth quarter due to four new printer products we introduced in the third quarter: the ZM400 and ZM600 label printers, two high volume mid-range products we introduced, plus a high performance card printer, the P630i and a new 6-inch photo printer.

We expect these products to make meaningful contributions to sales in future quarters. Additional new products are scheduled for release in 2008.

Supply sales rebounded significantly, increasing 8.7% in the quarter from 2.2% in the second quarter. A strong September set the stage for further improvement in the fourth quarter.

We are beginning to see the benefit from our Texas label converting facility, with an influx of new business from manufacturers in Northern Mexico. We also have new label converting capacity in Poland, which became operational in the quarter and will enable us to expand business in Central and Eastern Europe.

By geography, we've set sales records in North America, Latin America and Asia Pacific.

North American sales were up 8.6% to $105 million, from higher business activity through channels supplemented by several key wins in route accounting.

Sales in our retail vertical were flat year-over-year, but we made important gains in broadening our account base. Sales growth in every international region exceeded 20%.

EMEA sales, which include $4.8 million of foreign exchange gains, advanced 25.2% to $74.2 million. On a constant currency basis, EMEA growth was a solid 17%. All sub-regions within the territory contributed to the result.

Asia Pacific and Latin America also delivered strong growth. Latin America was up 22.9%, with several wins in retail and other verticals with mobile applications.

Asia Pacific sales increased 26.5%, driven largely from continued penetration in China, where sales were up over 50% with notable wins in manufacturing and government applications.

Consolidated gross margins came in above guidance at 48.2%, up from 47.1% a year ago and 47.6% in the second quarter.

We benefited both comparatively and sequentially from a favorable product mix, foreign exchange gains, and improvements in manufacturing variances. The drag of nearly 4 percentage points from WhereNet masked substantial progress we've made in improving the profitability in our core business.

Operating expenses of $67.6 million were within the forecasted range. They include one-time charges totaling $4 million or $0.4 of share related to the retirement of former Chairman and CEO, Ed Kaplan and board activities for the search and hiring of new CEO, Anders Gustafsson.

Amortization of intangibles and FAS 123R expenses totaled $7.3 million, including $1.7 million directly related to the CEO retirement.

A year ago, non-cash charges totaled $2.4 million. Excluding non-cash charges, third quarter '07 operating margin was 20.6%, up from 19.1% for the second quarter and 17.1% on a GAAP basis. Details on these pro forma results are contained in our press release.

Third quarter investment income totaled $4.4 million, with a return on beginning balances of 3.6%. Net income equated to $0.39 a share.

Free cash flow for the quarter amounted to $15.6 million net of acquisitions.

During the third quarter, we used $42 million to buyback 1.2 million shares of stock.

For the year-to-date, we have deployed close to $200 million in acquisitions and stock repurchases. An additional $145 million is earmarked for the Navis acquisition, to bring total capital deployment to approximately $345 million for the year.

DSO for the quarter was a comfortable 56.2 days. Inventory turns were 5.3. Our quarter-end cash position was $469 million.

We expect fourth quarter sales to be between $215 and $227 million. Earnings should be in the range of $0.38 to $0.45 a share. This forecast assumes a gross margin of between 48% to 49%. We expect operating expenses to be in the range of $68 million to $69 million. Our forecast includes up to $4 million each in FAS 123R expense and intangibles amortization. Effective tax rate for the quarter will be 34.5%.

That concludes my formal remarks. Thank you for your attention. And here is Anders for some concluding comments.

Anders Gustafsson

Thanks, Randy. Our third quarter results validate the strength of Zebra's core business and the success of our growth strategy. Expanding geographic presence, delivering applications in high-growth vertical markets and creating greater customer intimacy with high-touch sales modules are some of the activities that are enabling Zebra to extend global leadership and become a more formidable competitor.

My observation is that these are the right activities that can, and will lead to consistent sales growth.

Continued focus on operational efficiencies will enable further improvements in profitability and earnings growth.

In short, I believe there should be significant growth and profit potential in specialty printing and bar code labeling solutions.

Our capital deployments in higher growth adjacent businesses enhanced Zebra's growth prospects across multiple dimensions.

Our acquisition of WhereNet in the first quarter established Zebra as a leader in active RFID and real-time location systems. It also strengthened our position in key vertical markets for active RFID, such as, in industrial manufacturing, distribution and logistics, and aerospace and defense. We added GPS to our portfolio of identification and location technologies in the third quarter, with the proveo acquisition. This transaction also gave us a more meaningful presence in the airline industry.

With these transactions, we have clearly expanded the business opportunity with new customers for Zebra. Equally as important, they expand a breadth of solutions we are able to deliver to current large key accounts. We can build on our trusted position as a leading provider of bar coding and passive RFID identification solutions, which are well-suited for tracking items, cases and pellets.

Active RFID and GPS provides a more comprehensive ability to identify, locate and track critical assets. Established customers are already seeing the potential benefits of deploying solutions, incorporating these technologies to improve their business processes.

We believe that Navis will add another high value element for Zebra in delivering business improvement solutions. Complementing our data acquisition technologies, Navis' software systems optimize the flow of goods in and around the enterprise. The drive for greater efficiency in the global supply chain provides ample growth opportunities for this expanded set of Zebra solutions.

Thank you for your attention. We appreciate your time and interest in Zebra. We would now be happy to answer any questions you may have.

Question-and-Answer-Session

Operator

(Operator Instructions)

Anders Gustafsson

Do you have any questions, operator?

Operator

Yes, sir. Your first question comes from the line of Phil Alling from Bear Stearns.

Phil Alling - Bear Stearns

Hi, this is Philip Alling.

Anders Gustafsson

Hi, Phil.

Charles Whitchurch

Hi, Phil.

Phil Alling - Bear Stearns

You can hear me. Okay, good. Given the technical difficulties, I thought I would just double check to make sure that you can hear me.

Anders Gustafsson

Well, that's a good thing, currently today. We thought we have been so clear there were no questions.

Phil Alling - Bear Stearns

I appreciate the opportunity to ask some questions. So, with respect to the WhereNet and Swecoin acquisitions that you made in the last year as well as the beginning of this year, how have they performed with respect to your expectations and also as far as sort of the outlook going forward on your growth?

Clearly, you're making some acquisitions in the asset tracking area, diversifying from your core and the bar code printing space. How should we be thinking about relative growth in your asset tracking unit going forward versus the core bar code printing business. And now on a blended basis, what are your expectations at this point for longer-term growth going forward?

Charles Whitchurch

Well, I would say first of all, Phil, there are two parts to that question. One, how is Swecoin doing and how is the -- we will call it WhereNet prevailed, that puts a WhereNet going. Swecoin is doing really well. We are integrating that very tightly into our -- what we have characterized as our core business.

So that will not be going forward after this quarter, will be considered because we bought it exactly a year ago. It will be in the comparable results year-over-year and will be part of the core business.

The WhereNet acquisition is a little behind where we would have expected it to be at this point. That being said, we are fully expecting the combined business which would include, after we get clear HSR, the Navis transaction to be going substantially faster than the core business.

I can't give you a precise blended growth rate at this time, although I will say that after the first quarter we expect to be reporting on a segment basis. So the numbers will be crystal clear at that time, because the combined operations of these businesses assuming that we get clear HSR, we'll exceed 10% of the total combined sales of the company.

Anders Gustafsson

Andy, and again, I should emphasize that we are planning to have an analyst day in New York some time in the first quarter. So, we will be a little more clear about the plans going forward at that point.

Phil Alling - Bear Stearns

What could you say at this point as far as the margin structure, your asset tracking business unit clearly will be different go-to market strategy, much more reliance on direct sales as opposed to the channel and so forth?

Charles Whitchurch

I would say again, this is anticipating clearance from HSR, which has not happened. Okay, we are not closed on Navis. So, everything we have to say here is very circumspect. But again, assuming that that goes through, that Navis has a much, it's a software company.

So one would expect that the gross margins would be substantially higher and they are indeed higher. So we would see higher gross margins from that part of the business and somewhat lower operating margins at least out of the box until we scale up and expand the operations of the business.

Phil Alling - Bear Stearns

Okay.

Charles Whitchurch

And some more rapid sales growth, greater gross margin and somewhat lower operating margin out of the box.

Phil Alling - Bear Stearns

Okay. And with respect to this foreign exchange impact on the reported revenues, was there any meaningful currency impact revenue outside of EMEA, you did sort of give…?

Charles Whitchurch

No. The currency impact is isolated in EMEA, and overall for the company is $4.8 million and was roughly 2.6% in the year-over-year growth.

Phil Alling - Bear Stearns

Okay. And just one final little question for me just with respect to G&A, how should we be thinking about that going forward? You did mention the impact regarding the payment to Kaplan, that you showed in the third quarter or so, what…?

Charles Whitchurch

Well, we gave the guidance of $68 million to $69 million, that's all in number including 123R and the amortization of intangibles. I will tell you that excluding the acquired growth of the company's year-over-year operating expenses, we're up a little over 10% in the core business. Again I think it's going to have to -- we are going to have to leave it at that at this point Phil.

Phil Alling - Bear Stearns

Thanks very much. I will pass it along.

Charles Whitchurch

Again, I want to refer you to the detail provided in the press release on all the non-cash charges relating to the business. It breaks up the 123R and the amortization of intangibles.

Phil Alling - Bear Stearns

Thanks so much, Randy.

Charles Whitchurch

Yeah.

Operator

And your next question comes from the line of Ajit Pai from Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Hi. Good morning.

Charles Whitchurch

Hi, Ajit.

Anders Gustafsson

Hi, how are you?

Ajit Pai - Thomas Weisel Partners

Good. A couple of quick questions. The first one is just your guidance relative to normal seasonality that Zebra seen in the past, and just given the fact that your business momentum seems to be accelerating, North America and Europe and even in Asia. Why is your guidance so conservative? Were you seeing any early signs of weakness in some markets in your orders or why is it so conservative?

Charles Whitchurch

Well, first of all, we're not seeing any signs of weakness, business is quite good. And I would not characterize the guidance as particularly conservative. I think it's fair to say that Zebra likes to deliver results rather than talk about future performance that might not develop.

So, I mean I think that it is a reasonable guidance. It is certainly sequentially up by a decent margin in our view. So, I would not characterize it as particularly conservative.

Ajit Pai - Thomas Weisel Partners

Okay. So there is no sign of weakness anywhere, or business momentum that's accelerating, good to see it accelerate. You've discussed what the margin structures of the new businesses are, from a broad perspective.

And there's one other thing that I think, in prior calls that you had addressed that you're exploring, and then I think in the most recent call, you said that, that something that is not the highest priority right now and that could be setting up low cost manufacturing operations elsewhere. Is that still something that you're working on?

Charles Whitchurch

Yes. We are doing a pilot at the moment to look at outsourcing as a potential benefit to us. We haven't concluded the pilot yet. So if you hold with us for another quarter or so, we'd be able to share some more life on that at that point.

Ajit Pai - Thomas Weisel Partners

Right. But when you're looking at it, instead of using an outsourcing company or vendor, have you considered sort of setting up a Zebra wholly-owned operation overseas as well, or is that, it's primarily looking at outsourcing?

Anders Gustafsson

You mean for us to do in-house manufacturing overseas?

Ajit Pai - Thomas Weisel Partners

Yes.

Anders Gustafsson

No. We have not looked at that. I think that the contra-manufacturers, they manufacture other people's goods for living, I think that they are quite good at it. I think we can probably get much more savings by doing it that way than setting up our own wholly-owned subsidiary as you suggest.

Ajit Pai - Thomas Weisel Partners

Got it. Thank you.

Operator

And your next question comes from the line of Jeff Rosenberg of William Blair.

Jeff Rosenberg - William Blair

Good morning. Randy, I wanted to ask you another angle on the operating expenses. You mentioned with the expenses for the CEO transition, they got you into the end of the range that you had for the quarter. Were those expenses anticipated in your guidance or was I confused about the growth [of the highest]?

Charles Whitchurch

No, they were not anticipated in the guidance.

Jeff Rosenberg - William Blair

Okay. So if you backed those out to consider your performance relative to the guidance here, expenses were lower and yet you're guiding for a pretty significant sequential increase kind of apples-to-apples with that taken out in the fourth quarter. So can you maybe look at it from that perspective and give us some insight there?

Charles Whitchurch

Well, again Jeff, we roll up a forecast of operating expenses from our operations every quarter, and again this does include the full bulk load of amortization of intangibles and the 123R expenses in the numbers. So, yeah, I would think this is the right number to give you.

Jeff Rosenberg - William Blair

All right. I was just -- it's about a $5 million increment at the midpoint. So it was a substantial increase in expenses. So I just looked in to see if there is anything that in fact to begin there.

And in the sales growth side, could you maybe just taking a step back and looking at the success you're having in your -- the foreign currency that the high-teens growth you've got relative to the growth in North America.

I mean, is there something inherently that you've been able to capitalize on in Europe that's less available to you in North America or perhaps, any comedy could make us the opportunities you have in North America that you feel like that number could improve? And maybe just some high-level comments there and the things you've been doing this year to improve North America?

Mike Terzich

Jeff, this is Mike Terzich. I'll take your question. On the European front, as you know, over the last couple of years, we've been pretty active and expanding our sales coverage models in Europe and we have certainly taken advantage of the Zebra brand and the multinational migration that has occurred in within the region, particularly in a couple of the very heavy growth areas, Eastern Europe for instance, and in India, as well.

So, I think our strategy has been to be there to build infrastructure, local sales and marketing infrastructure and continue to develop the channel to support where the business is migrating too. And that has been in play for us for several years now and it's been working very well.

Now the question in North America has been really one of diversification vertically for us. So, the business being very steep and strong in the supply chain manufacturing space and in the retail space, our strategy has been to smooth out some of the lumpiness associated with parts of that business by extending our solutions vertically. So we've been concentrating on new vertical spaces for Zebra healthcare, government, our [ready] mobile workforce space that we've talked about in the past, and that's giving us growth and it's offsetting some of the lumpiness that we see, particularly, in the retail space.

Jeff Rosenberg - William Blair

Okay. Last question I had real quick was, is there anything incorporated in guidance for the new acquisition or is that any expenses and/or revenues there to completely incremental to what you've given us in guidance?

Charles Whitchurch

New acquisition meaning the Navis deal?

Jeff Rosenberg - William Blair

Yeah, any expenses there?

Charles Whitchurch

There is nothing in there from Navis. Navis is not closed and there is nothing in our guidance related to that acquisition.

Jeff Rosenberg - William Blair

Okay, thanks.

Operator

And your next question comes from the line of Chris Quilty from Raymond James.

Chris Quilty - Raymond James

Hello, guys.

Charles Whitchurch

Hi, Chris.

Anders Gustafsson

Hello.

Chris Quilty - Raymond James

You may have given it and I may have missed it, Randy did you break out organic growth in the quarter?

Charles Whitchurch

I didn't break it out specifically; I said it was in the double-digits.

Chris Quilty - Raymond James

Okay.

Charles Whitchurch

I mean, we had a -- the core business did really well in the quarter, I will say that. And we're quite pleased with that. We've got some really great results internationally, and even within North America which is highly, which is one of the retail verticals highly concentrated in our business.

We had relatively flat sales in the retail vertical, but we made some important gains in diversifying our account base. So, moving into a position where we want to be able to offset weakness in one large account that strengthened another. And we seem to be able to do that in the quarter, and despite the fact that the retail vertical was relatively flat, I think strategically, we're really pleased with the results we got.

Chris Quilty - Raymond James

So would you say your biggest surprise in the quarter by product or by geography was North America then, in terms of surprise better than you had expected?

Charles Whitchurch

No, I think actually the biggest surprise in the quarter was how really strong the international business was. I mean everything was up really in the mid-20's, it was a terrific result.

Chris Quilty - Raymond James

Okay.

Charles Whitchurch

And the other thing that was really, I think that was really good for us in the quarter was the fact that we continued to make gains in improving the gross margin. This is something we've talked about with you guys for multiple quarters.

And our operations guys have done heck of a job in fixing some of the issues we're dealing with there, and it really doesn't show up quite as much in the numbers of the result that we actually got, because the WhereNet business drags the gross margin down a little bit. So it really masked the level of improvement work that we have been able to get in the core business.

Chris Quilty - Raymond James

There was actually a question that I was going to ask, a clarification, you had said in the prepared text that WhereNet was a 1% drag, but was that gross margin or EBIT?

Charles Whitchurch

That's gross margin.

Chris Quilty - Raymond James

Okay. But shouldn't WhereNet longer term be accretive to the gross margin because of the high…?

Charles Whitchurch

Yeah. We would expect those margins to improve as their sales mix shifts much more to a software and maintenance component and, of course, again assuming the Navis transaction gets approved, there's going to be an even bigger shift there, because Navis is principally a software company.

Chris Quilty - Raymond James

Okay. And when you mentioned that WhereNet was a little bit more behind than where you had thought it would be at this point, were you talking primarily about the financial contribution or where they are in terms of business development pipeline, order book and stuff like that?

Charles Whitchurch

It's the financial contribution at this point.

Chris Quilty - Raymond James

Okay.

Charles Whitchurch

The one of the areas where WhereNet has had historically a quite a strong presence is in automotive and that as a segment have been somewhat weaker this year.

Chris Quilty - Raymond James

I am surprised, surprise.

Charles Whitchurch

Yeah.

Chris Quilty - Raymond James

And also talking on the gross margins, you had mentioned earlier -- that question got asked. Sorry about that. Order delays, last quarter, you had mentioned a number of things that were pushing out to the right and should land in Q3, Q4, can you give us a sense of how those delayed orders are coming in?

Mike Terzich

Chris, this is Mike, and yes, we did mention in the second quarter call, that in the eleventh week of the quarter we had some push out, primarily retail centric and we were very pleased that those orders came in full in the third quarter. So we recovered what was pushed from Q2 into Q3, above the midpoint of the quarter. So we are in good shape there.

Chris Quilty - Raymond James

Okay. And I know the Ed Kaplan rule for one question isn't in place, but I will ask only more question, which is the consumable business, which you normally mentioned as sort of a leading indicator, hard for us given the new facilities and everything else that's going on to kind of figure out what the real growth and margin trends are there, but what is the consumables business telling you today?

Charles Whitchurch

The consumable business, I will tell you, it's a tale of a couple of different stories, and in particular, the first half of the year it was a little softer than we would like to see, primarily as a result of two critical markets for us in North America.

One being the retail market, which we talked a lot about, and the other being automotive supply chain. We did see some second half of the quarter surge primarily in the retail space which was good to see, because that's usually tied to some of the back-to-school initiative that are going on in retail, but that has improved our outlook quite significantly.

And then secondarily, we have been doing some expansion, as you know, with that converting, our converting capability in Europe and we are picking up nice pieces of business in proximity to our locations. Now we have three locations in Europe, Poland Holland and the north of England.

Now we are picking up nice pieces of business close in the retail space and in some of the manufacturing extended supply chain space. So it's been going really well. And if you check with the industry as a whole, our growth is significantly better than industry projections and if you were taking some share in this space.

Chris Quilty - Raymond James

And the taking share attributed to the local presence?

Charles Whitchurch

Yes, definitely.

Chris Quilty - Raymond James

Okay, great. Thank you, gentlemen.

Operator

Your next question comes from the line of Greg Halter from Great Lakes Review.

Greg Halter - Great Lakes Review

Good morning. And thank you for taking the time. Just a quick one on ScanSource, I wondered if you could delineate what percentage of that company presented your sales?

Charles Whitchurch

Greg, I don't have that handy. Let me look it up here and will get back in. Okay.

Greg Halter - Great Lakes Review

All right. And relative to ScanSource, with WhereNet and potentially [if your] acquired Navis goes through, are they involved in that at all, or is that totally outside of their scope?

Charles Whitchurch

That's outside of ScanSource scope today. There might be overtime some opportunity to work with them to cooperate in that area but today that will be beyond what they do.

Greg Halter - Great Lakes Review

Okay. And relative to WhereNet, I think in the past you have talked about net operating loss carried forward there. Has there been any decision made on what's happening with those or how that stands?

Charles Whitchurch

No, not at this point and the ScanSource is little over 15% of sales in the quarter.

Greg Halter - Great Lakes Review

Okay, thank you. And on the RFID side, I know there were some mentioned on the second quarter call about that that there is some [life stirring] there relative to the core RFID, I guess if you will. I wondered if you could provide us with an update on what you saw in on the third quarter and what you see going forward?

Mike Terzich

Greg. This is Mike, and we saw some improvement in the -- are you talking about the passive RFID space.

Greg Halter - Great Lakes Review

Correct.

Mike Terzich

Right. And we saw some improvement in the quarter. There has been a little bit more activity primarily at the government level and there were couple key pieces of key project that we actually won in the quarter through the armed forces. So, we are beginning to see a little bit of uplift in that particular space. The retail side has been relatively quite.

Greg Halter - Great Lakes Review

Okay. And one last one relative to the investment income, I think Randy had mentioned, 3.6% return on beginning balance and I think that's compared to 5% in the second quarter. I just wondered if you could explain the differential in the rates of return?

Charles Whitchurch

We liquidated some positions in the second quarter, where the profit was, as you say, deferred onto the balance sheet, so was reported under the P&L. And secondly, rate scheme in the portfolio came down, and we have less money to invest. So from a combination of factors, I mean that the reported numbers were a little weaker in the second quarter -- in the third quarter than the second.

Greg Halter - Great Lakes Review

Okay, great. Thank you.

Operator

Your next question comes from the line of Reik Read from Robert W. Baird.

Reik Read - Robert W. Baird

Hey, good morning. I just want to go back to the operating expense side of the things. In the last couple of quarters, you guys have actually performed.

Reik Read - Robert W. Baird

Hello?

Charles Whitchurch

Yeah. We hear you.

Reik Read - Robert W. Baird

They came back at me. Those operating expenses have been relatively lower than what you had thought, and now you're seeing that's boost up. Were there some things that you delayed or deferred and they are coming into the fourth quarter, or is this kind of a level that we should be looking at things now?

And can you talk a little bit about, Randy I know you've talked in the past about some of the selling initiatives in driving forward, is that something that's now adding more to the expense side?

Charles Whitchurch

Well I think, there is couple of things. When we've got, we do have the acquired companies coming in and I think in terms of operating expenses going forward, I think what we're going to do after the -- in this analyst call, we'll be a little more specific about future numbers and things like, Analyst Day will be a little more specific about numbers going forward because the business model will be different because of these always acquired companies.

To step up in the quarter, is largely related to the timing of expenses that we are anticipating, they have in the quarter and I don't think it necessarily represents a new higher level of expenses. Now, including in that number is a $7 million of 123R and amortization of intangibles. So, you really have to strip that out from the core, real spend rate if you will. You get a better look of what's going on.

Reik Read - Robert W. Baird

Right. Okay.

Charles Whitchurch

Okay.

Reik Read - Robert W. Baird

Okay, good enough. And I guess just directionally, are there any things that you guys are doing from an internal initiative that might affect those expenditure [IE]. Are there new projects or programs coming underway that could cause them to boost up or will they, and I am just talking directionally, I am not looking for guidance on the numbers.

Charles Whitchurch

No, I would say no.

Reik Read - Robert W. Baird

Okay. And then with respect to the gross margin, the manufacturing improvement, how much of that, I mean if you look at the 60 to 70 basis points sequentially, how much of that is due to the manufacturing variance improvement?

Charles Whitchurch

On a year-over-year basis, about 1.2 points.

Reik Read - Robert W. Baird

Okay. And then, Mike just on the RFID business within the DoD. Is that more of a short-term boost or is that something that you see is relatively sustained as they start to open up Asia?

Michael Terzich

Well, I would like to say, we see it as a sustainable. I think we've seen just in the pipeline, the activity pipeline has improved which gives us a good indicator that, I think they've centered on a couple sweet spots from an application standpoint, that's creating some opportunity for us. So I think at this point, we see it as sustainable.

Reik Read - Robert W. Baird

Okay. And then just last one, share repurchase. You guys announced the $1.2 million in the quarter, is that something where you're planning to be opportunistic or is that something where you think you'll be regular repurchases as you kind of look forward?

Anders Gustafsson

I think more generally, generally you saw return to our investors is clearly our top priority and accessing our capital structure is also on my agenda for the rest of this year here.

Return on investment capital would be one of our key metrics and say, revenue and earnings growth will be the key operational drivers, but capital structure is also effective which we will address. So, I think we'll get back with some more detail on that and probably the Q4 or the Analyst Meeting we have in February.

Reik Read - Robert W. Baird

Okay. Thank you, guys.

Operator

Your next question comes from the line of Andrew Abrams from Avian Securities.

Andrew Abrams - Avian Securities

I was wondering if you could go a little further on the manufacturing variance side. You mentioned 1% to 2%, is there a lot more behind that or is that more behind that first off?

And second, can we talk just a little bit about Navis, should it close? What kind of a growth rate are we looking at for this company historically; I mean you don't have to go forward you can go back?

Charles Whitchurch

Well, I'm really going to decline to answer any questions about Navis at this point, because the transaction hasn't closed, okay. So that's, really kind of off-limits for us at this point.

As far as the gross margin improvement, I would say we've really gotten to the point now where we've squeezed out most of the variances that we have been talking about for last several quarters as that relates to, what I characterized as the blow back from the loss conversion of a little over a year-ago. So, I would not anticipate a lot of additional gross margin improvement coming from that source.

I think we have reached a point where gross margin improvement is going to come from other initiatives that we are looking at, and the normal impact that we get from product mix changes in foreign exchange. But I think there are really two factors that are part of the principal drivers of gross margin.

Andrew Abrams - Avian Securities

Thanks.

Operator

Your next question comes from the line of Jeremy Grant from Stanford Group.

Jeremy Grant - Stanford Group

Hey. Congratulations on the great quarter.

Charles Whitchurch

Thank you.

Jeremy Grant -Stanford Group

I think most of my questions have been answered, that happens when I am the last in the queue. Just wanted to confirm, this might have been asked that there was a note in the press release the G&A expenses add, I think it's about $4 million on one-time charges with Ed leaving and all that going on, does that mean that G&A would have been right around $17.5 million for the quarter without that?

Charles Whitchurch

That's right.

Jeremy Grant -Stanford Group

Okay. I think that's all I had. Thanks.

Charles Whitchurch

Thank you.

Operator

Your next question comes from the line of Kevin Starke from Weeden & Company.

Kevin Starke - Weeden & Company

Two questions. And is there a particular Euro rate embodied in your fourth quarter forecast?

Charles Whitchurch

Yeah, what we use going forward is the current rate.

Kevin Starke - Weeden & Company

All right, okay. And the second question, rough ideas on the number of units sold in the third quarter?

Charles Whitchurch

I'll give you more than a rough idea.

Kevin Starke - Weeden & Company

Okay.

Charles Whitchurch

But you are going to have to hold a minute while I look it up.

Kevin Starke - Weeden & Company

While you are doing that.

Charles Whitchurch

Yeah.

Kevin Starke - Weeden & Company

It may be premature, but you had mentioned a week ago on the call about Navis that you were looking at what integration and synergy possibilities there, and it sounded like you were going to be looking at that pretty quickly. Have you come up with anything else that you can share with us?

Anders Gustafsson

From an integration perspective, we are looking to certainly get working on that very rapidly to start the plan for what the combined organization should look like, once we have, assuming we get all the approvals and everything, but once the acquisition goes through.

But the synergies were more on the top line synergies, really than they were in the bottom line. We're buying the company for growth, but we were also be looking at how we can leverage particularly our shared services within the company, so finance, HR, IT and so forth.

Kevin Starke - Weeden & Company

Between WhereNet and Navis and the Zebra core business, do you feel that there might be a little too much overlap between your network of global offices, that some of them could be shut?

Anders Gustafsson

Yeah. That's part of what we would look at in our integration plan. But so far, we have a reasonably good global footprint. These other companies are much smaller, much smaller footprints and we'll be looking to see if there are opportunities to do that, but that will be fairly minor.

Kevin Starke - Weeden & Company

Okay.

Charles Whitchurch

Kevin, your unit count is 228,000.

Kevin Starke - Weeden & Company

Thank you. That's all for a moment.

Charles Whitchurch

Thanks.

Operator

And you have a follow-up question from the line of Reik Read from the Robert W. Baird & Co.

Reik Read - Robert W. Baird & Co.

You talked about with respect to gross margins, the manufacturing variances are largely done, but there are more improvement opportunities. Are these improvement opportunities beyond the outsourcing that you alluded to before and can you talk a little bit about the timing of when you might start to see those?

Reik Read - the Robert W. Baird & Co.

Well, they are actually. They are improving opportunities that we are working down across the supply chain, that are not related to the outsourcing and we would expect to start seeing those really next year.

Reik Read - Robert W. Baird & Co.

Okay, great. Thank you.

Operator

And I am showing no further questions in queue.

Charles Whitchurch

Okay. At this point, we are going to conclude the call. Thank you for your participation today. Just as a reminder, the conference call for our fourth quarter and year end results is currently scheduled for February 6, 2008 at 10 O'clock Central Time. Thank you for your participation today.

Operator

And this concludes today's conference call. You may now disconnect.

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