ZEBRA TECHNOLOGIES CORP — Call Transcript 2020

Speaker 12: Good day, and welcome to the Q3 2020 Zebra Technologies earnings conference call. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

Speaker 10: Good morning, and welcome to Zebra's Q3 conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Slide two conveys that the forward-looking statements we make today are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Nathan Winters, our Acting Chief Financial Officer. Anders will begin with our Q3 results. Nathan will provide additional detail on the financials and discuss our Q4 outlook. Anders will conclude with progress on advancing our Enterprise Asset Intelligence vision and trends in our end markets. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Now let's flip to slide four as I turn the call over to Anders.

Speaker 1: Thank you, Mike. Good morning, everyone. Thank you for joining us. We are honored that our solutions are empowering frontline workers in the battle against COVID-19. I am proud of our employees' resiliency and focus on serving our customers' critical needs during these challenging times. Our top priority continues to be protecting the health and well-being of our employees, customers, and partners as businesses continue to progress with their reopening plans. In Q3, our results continued to be pressured by the global macro environment. For the quarter, we realized net sales growth of 30 basis points, adjusted EBITDA margin of 20.3%, which contracted by 240 basis points, and non-GAAP diluted earnings per share of $3.27, a 5% decrease from the prior year. As a result of excellent execution by our teams and a faster than expected recovery in demand, each of these measures exceeded our outlook. Demand from our large strategic customers has been at record levels, driven by accelerated trends to digitize and automate workflows. Not surprisingly, the pandemic has disproportionately impacted our smaller customers and certain end markets, which has resulted in a significant shift in business mix. Together with premium shipping costs, this has weighed on gross margin. In light of this pressure, we have continued to diligently manage discretionary costs to preserve profitability and cash flow. Despite the challenging environment, our enterprise customers have been prioritizing spend with Zebra, and I would like to highlight some notable Q3 success stories. We expanded our relationship with a leading e-commerce retailer experiencing significantly increased order volumes. They require trusted technology solutions that enable improved supply chain and order fulfillment execution to empower their labor force. We are deploying our mobile computing, scanning, and printing solutions across their growing global footprint. Innovation, quality, and value are critical partner attributes cited by this customer, and we are proud that our team is delivering to their high standards. A hospital system in Denmark has chosen to replace a competitor with our clinical point of care solution. In Q3, they began a multi-quarter deployment of our healthcare purposed TC5 series mobile computers and accessories, which will interface seamlessly with their electronic medical health record system. We have continued to deploy TC7 series mobile computers to USPS postal carriers as planned and are now passing through their peak holiday season, expecting to resume in late Q1 with the goal of completion by mid Q3. We are proud that we are able to help our customers meet their mission-critical needs in an increasingly on-demand economy. We continue to view acquisitions as a vector of profitable growth for Zebra and a way to elevate our role as a solutions provider. In early September, we closed on the Reflexis acquisition. In a few minutes, I'll elaborate on how this acquisition is synergistic to our offering. With that, I will now turn the call over to Nathan to review our Q3 financial results and discuss our Q4 outlook.

Speaker 11: Thank you, Anders. Let's start with the P&L on slide six. Net sales increased 30 basis points before the modest net impact of currencies and acquisitions. As Anders mentioned, large order volume was much stronger than the prior year. This was offset by a decline in small and mid-sized business through the channel, which disproportionately impacted printing and data capture. Our Enterprise Visibility & Mobility segment sales increased 4%, driven by solid growth in mobile computing and services. Our Asset Intelligence and Tracking segment, including printing and supplies, continue to be most impacted by the global recessionary environment, with sales decreasing 7% from the prior year. This was a notable 18-point sequential improvement from the Q2 decline. We realized solid growth in our managed and professional services and Zebra Retail Solutions. Location Solutions declined from last year due to lower project activity during the pandemic. We realized significant sequential improvement in each of our regions from Q2 as we continue to recover from the peak of the pandemic. In North America, sales increased 6%. Mobile computing and data capture returned to solid growth, and services continued to perform well. EMEIA sales were flat. Services and mobile computing were bright spots. We also continue to see strength in Central and Northern Europe. Sales in our Asia Pacific region declined 13%. China was a bright spot, returning to modest growth. Latin America sales declined 20%, with all major product and service categories declining. Adjusted gross margin contracted 390 basis points to 43.8%, driven primarily by more than three points from unfavorable business mix and nearly one point from premium freight costs, which was partially offset by improved services margin. Underlying margin trends across the business, excluding mix dynamics, remain healthy. Adjusted operating expenses declined $17 million from the prior year period and improved 150 basis points as a percentage of sales. This improvement was primarily due to disciplined cost management and lower compensation expense while preserving our planned investments in the business. Q3 adjusted EBITDA margin was 20.3%, a 240 basis points decrease from the prior year period, driven entirely by lower gross margin. We drove non-GAAP earnings per diluted share of $3.27, a $0.16 or 5% year-over-year decrease. To the balance sheet and cash flow highlights on slide seven. We generated $482 million of free cash flow in the first nine months of 2020. This was $106 million higher than the prior year period, primarily due to a lower use of working capital, as well as our expanded accounts receivable factoring program. Our balance sheet is strong. From a debt leverage perspective, we ended Q3 at a comfortable 1.8x net debt to adjusted EBITDA ratio, 0.5x higher than last quarter, due to financing the acquisition of Reflexis. Now turning to slide eight. We have demonstrated that we can deliver solid results in a challenging economic environment while continuing to invest in our future. Our consistently strong free cash flow generation is driven by our capital-light business model, flexible cost structure, diversified end markets, strong execution, and disciplined cost management. Let's now turn to our outlook. We are encouraged by the faster than expected recovery with small and mid-sized businesses and are beginning to realize the benefit of pent-up demand from many customers who have paused their spending earlier in the year. Based on these trends and our healthy channel inventory levels, we expect Q4 adjusted net sales to increase between 3% and 7%. This outlook assumes an approximately 150 basis point additive impact from the acquisition of Reflexis and a neutral impact from foreign currency changes. We believe Q4 adjusted EBITDA margin will be between 21% and 22%, which assumes modest operating expense leverage from the prior year. Gross margin is expected to be slightly lower than last year, reflecting higher large order mix in a soft but improving macro environment, as well as an offsetting year-on-year impacts of premium freight and tariff expense. Non-GAAP diluted EPS is expected to be in the range of $3.70 to $3.90. You can see other modeling assumptions on slide nine. Note that we now expect free cash flow to be at least $650 million for the year, which is higher than 2019. With that, I will turn the call back to Anders to discuss how Reflexis is synergistic with our Enterprise Asset Intelligence vision, as well as trends in our end markets.

Speaker 1: Thank you, Nathan. Slide 11 highlights how we are building on our foundational capabilities to elevate our value proposition with customers as a solutions provider. Our unmatched access to frontline operational data from our vast installed base of products uniquely positions us to solve our customers' complex challenges at the edge. We are investing in emerging technologies that help our customers better orchestrate their workflows by leveraging real-time data to gain actionable insights. We are excited to have Reflexis on board, which further helps Zebra bring our Enterprise Asset Intelligence vision to life for retailers and other end markets. Reflexis is a demonstrated leader in intelligent workforce management and task execution. Their platform is utilized by hundreds of retailers around the globe to drive employee productivity and retention, while also improving customer engagement. Reflexis is synergistic with our existing suite of solutions as a service. As you can see on slide 12, these include SmartCount, which is an innovative self-scan and physical inventory management solution. Our SmartSight robotic solution, which uses automated intelligence to help identify issues on the store shelf in real time. Our Workforce Connect data and voice communication and collaboration application for mobile workers. Zebra Prescriptive Analytics, which provides data-driven insights and a prioritized list of prescriptive actions that help maximize efficiency and reduce shrinkage. Zebra's suite of solutions work in unison with our product portfolio to provide real-time contextual tasking. This capability is critical for successfully addressing the inevitable unplanned events that occur throughout the workday. Over the next few quarters, we will continue to invest in the seamless integration of Reflexis' market-leading platform with our complementary software offerings to optimize the experience for frontline workers. We are also investing in our go-to-market efforts to drive accelerated traction with our unmatched suite of solutions. We believe that our enterprise customers will realize a compelling ROI by empowering all of their associates with these solutions. On slide 13, we provide an update regarding the mixed impacts we are currently seeing in the primary vertical markets that we serve. We also highlight the exciting longer-term opportunities in our end markets as customers invest in our technology in an increasingly on-demand economy. Trends are improving since our last quarterly update, although it is still a mixed picture depending on the sector. In healthcare, our solutions help hospitals intelligently flex their capacity to serve patients. There was a pause in non-critical care during the peak of the pandemic, straining the budgets of health service providers, which is changing now that elective procedures are resuming. Longer term, the need for increased real-time visibility into the entire patient journey and the demand for innovative solutions to provide safe and efficient care continue to make healthcare a high growth end market opportunity. Retailers are prioritizing investment in our technology for their complex omni-channel fulfillment strategies and related warehouse automation needs. Demand from large retailers is at record levels as e-commerce and buy online initiated transactions have increased dramatically through the pandemic. We have also begun to resume business with many department stores and specialty retailers that have been reopening their doors. In the transportation and logistics space, strong e-commerce growth continues to drive parcel volumes and last mile delivery, which is favorable to Zebra. Passenger airlines, rental car providers, and other related businesses remained challenged. The manufacturing sector continues to be most impacted with COVID-19 and global trade tensions. Key segments within process manufacturing, such as food and pharmaceutical companies, have held up relatively well, continuing to operate through the pandemic. We've seen mixed trends in discrete manufacturing with those in aviation and discretionary specialty goods particularly challenged. A bright spot is our solid recovery in Chinese manufacturing. In closing, we are successfully navigating through this challenging environment while we continue to invest in advancing our Enterprise Asset Intelligence vision. This is enabling Zebra to emerge from this crisis in a stronger competitive position. We also believe that our longer term prospects are strengthening as secular trends to digitize and automate workflows have accelerated. Now I'll hand the call back over to Mike.

Speaker 10: Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible.

Speaker 12: Our first question will come from Tommy Moll with Stephens. Please go ahead.

Speaker 14: Good morning, and thanks for taking my questions.

Speaker 1: All right. Good morning, Tommy.

Speaker 12: Speaker, is your line open? Oh.

Speaker 14: Anders, I wanted to start on the Reflexis deal. Could you articulate for us how important integrating software as part of your revenue mix will be going forward? What are some of the strategic rationales? In other words, what does that allow you to do in terms of increasing stickiness with the customer relationship? What are the other advantages it brings to Zebra? As a related point, as you do head into more software-driven sales, should we think about that market as one that's more competitive than where you've traditionally competed? How do you want to frame up the competitive dynamics there? Thank you.

Speaker 1: Yeah, that's good. I'll start and then I'll ask Joe Heel to help out also. Reflexis is a great company. We're very excited that it's part of our portfolio, part of the Zebra family here now. It's been a demonstrated leader in intelligent workforce management and task execution for many years, and it's been deployed by hundreds of retailers around the globe to help drive employee productivity and retention. Many of those customers are common to Zebra and also to our Zebra Prescriptive Analytics solution. When we look at Reflexis and Zebra Prescriptive Analytics and other software solutions we have, we see them as being very synergistic with our overall solution. If you think of our framework around sense, analyze, and act, I think that's probably the easiest way maybe to show how we think about creating more complete solutions for our customers. We have had historically a great strength around the sense and some in the analyze part. Being able to sense what's happening in the physical world has been kind of our foundation. Over the last few years, we have expanded our capabilities around the analyze and the act side quite a bit. Both Zebra Prescriptive Analytics and Reflexis are examples of that. Now, prior to actually the acquisition of Reflexis, we had a number of customers ask us to do more tight integration between Zebra Prescriptive Analytics and Reflexis. They felt that that would be something that would help get more value out of those investments. Zebra Prescriptive Analytics can then continue to feed actions into Reflexis' action engine to help combine all the different actions that the retailer might do in a prioritized way. Then we can leverage our other software assets like Workforce Connect to be able to tie it back into our mobile computers. Our store associates can either scan items in the store or enter other data that can be fed into ZPA or into Reflexis, also then be receiving updates or actions from that the Reflexis system can deliver even greater value by being able to do that. For Zebra as a whole, with our suite of solutions as a service, we can become more strategic to our customers. We can start enabling them to address more complete workflows. By that, we can increase the ROI of our overall solutions and be a more strategic thought partner as they think about how they develop their business. We definitely feel that this is a very compelling path for us, and very excited about what we can do with this. Joe, you want to add something?

Speaker 7: Perhaps I'll underline two things that you touched on. One is the fact that we're synergistic, not just on the product level, as Anders described, how we think we can bring together the different product capabilities we have, but certainly also on a go-to-market and sales level, where we have a very strong share in the retail market already. Bringing Reflexis to those retail customers is immediate cross-sell opportunity that we have. We're actually discovering that it also works the other way around, that Reflexis has some customers that they can bring us into and cross-sell that way. That leads into the strategic opportunity that Anders described, which is Reflexis generally has a strong presence in the operations side of retailers. This now gives us an opportunity to solve their problems strategically. This perhaps also addresses the second part of your question around, do we see this as a more competitive space? Certainly, there are different competitors in the pure workflow software area. However, none of them have the capability that we have to bring together the sense, analyze, act part of the EAI vision and to solve the problem holistically. We look at this as a space where we can now differentiate ourselves actually from both the traditional competitors that we had and the competitors that Reflexis currently has.

Speaker 1: Yeah, just to round out, say, I've been on the phone with many of the largest customers of Reflexis over the last month or two, and I'd say that uniformly, they are very excited about the combination. They are passionate about their Reflexis solution, but they also see the value that a combination with Zebra and the extra resources we can have and our vision for how we can continue to add value to their operations. I think so far it's been a great feedback from the market and from our customers.

Speaker 14: Thank you all. That's all very helpful. As a follow-up, I wanted to shift to some of the end market commentary you offered, Anders. Specifically, within retail and e-commerce, it sounds like some of the larger customers have accelerated their plans for the omni-channel integration or leaning into their e-commerce platforms. Two related questions. How durable do you see that trend being? Or maybe you could frame up qualitatively, if not quantitatively, how far ahead you think your current backlog gives you visibility into maintaining a robust pace of sales. Moving to the smaller customers or potential new smaller customers, are you seeing anything, not even in terms of order trends, just interest level, that suggests that maybe the playing field here has expanded? If you just look around the retail landscape, they're a lot more engaged in omni-channel or talking about it at least now than they were a year ago. I just wonder if maybe there's a TAM aspect to this dynamic as well, where it's shifted in your favor. Thank you.

Speaker 1: Yeah, I'll start, and then I'll ask Joe to add a little bit of color to it also. First, I think in this environment, our solutions have become even more critical for our customers. We are, I'd say, uniquely positioned to empower frontline workers across all our vertical end markets, and COVID-19 has been accelerating a number of secular trends around digitization and automation. It's probably most apparent in retail, around e-commerce, around omni-channel, and buy online, pick up at store. Here we've seen, particularly around mass merchants, grocers, and e-tailers, that they have been the quickest, I guess, to pick up on this, and that's about two-thirds of our business. I'd say, the largest retailers have mostly been the most aggressive or the earliest to start adopting and investing in solutions around omni-channel and e-commerce. They have seen a great growth in their omni-channel and buy online, pick up at store businesses, and they still believe that there's lots of market share that they can continue to grow and take. They are continuing to invest heavily in building out their capabilities and scaling their capabilities compared to where it was, say, just six months back. For smaller retailers, I'll say, generalizing a bit now, they were maybe not quite as quick to invest in omni-channel capabilities. It's a big investment and a complicated one at times. I think the COVID-19 and the changes in customer buying behaviors, and the step-up in change in how comfortable consumers are with omni-channel and buy online, pick up at store, as example, has made it, I think, abundantly clear for smaller retailers too, that if they want to compete, they need to build these types of capabilities. We see the pipeline of business around these larger trends around digitization, automation, and particularly in retail, as quite robust, and we think that this is a trend that will be going on for quite some time. With just saying that I think for now we see then the pipelines of these types of opportunities as we look into 2021 as being as robust as we would've expected them to be in prior years at this time. Joe?

Speaker 7: Yeah. I'll add perhaps two thoughts. I do think there is a TAM expansion that's going on, I see it a little differently than you were perhaps suggesting. One big area, it has to do with the fact that in order to enable all of these omni-channel capabilities, you need a deep capability in the company more broadly than just at the front where the items are being picked up. Two things in particular that you need to do that I think favor us in this case is, number one, you need to enable your associates in your store, because that's where most of the instant omni-channel capability is being created. That means you need to digitize and give every worker a device in some form. We're far from that today, so that's a TAM expansion. The second piece is you need to extend that modernization into your supply chain. We're seeing a lot of activity in terms of digitizing and automating the supply chain, and that's clearly related to this acceleration of e-commerce.

Speaker 14: Great. Thank you all. I will turn it back. Appreciate it.

Speaker 12: Our next question comes from Jim Ricchiuti with Needham & Company. Please go ahead.

Speaker 6: To follow up on some of the last commentary that you were making, Anders. It sounds like you're still anticipating a fairly robust environment with your larger customers, so it's not as if potentially there's some digestion from the investments that they've been making. Then as it relates to the small, medium segment of the market, I wasn't sure to what extent you are seeing recovery there. Is there the potential over the next one to two quarters that you could have both areas of the business, both large accounts and the SMB, actually moving in a consistent fashion toward stronger growth?

Speaker 1: Yeah. First, I think we're seeing a faster than expected improvement in our end markets. We're cautiously optimistic about how the economy will recover into 2021. I think here, our industry leadership and our investments in our business will also enable us to rebound stronger than our competitors. To that point, that's why we feel confident to guide for both top and bottom-line growth in Q4. When we looked at our Q3 performance here, our run rate was improving. It's not back to pre-COVID-19 levels. It is definitely improving and strengthening. I think that was something we saw globally. Our large deals were obviously very strong in Q3. We still have a good pipeline into our larger customers and how they're looking to invest in Q4 and beyond. Joe, do you want to add anything to this also?

Speaker 7: Yeah, perhaps just two things. If you look at our pipeline, as an indicator, it's as strong as it was on a relative basis a year ago. We have a strong pipeline that gives us good confidence, and our run rate has been recovering. Maybe we didn't say that clearly enough, but it's clearly a driver of the growth that we've been seeing, and we expect that to continue as well.

Speaker 6: Got it. Just as a follow-up question, this relates more to some reports that we've begun to see, including one by a large retailer that had been considering deploying in-store robots for inventory analysis and has now pulled back apparently on that initiative. I know you guys have looked at that market, but I guess my question is, as you look at the opportunities there, does it appear that it looks like some of the major retailers may opt for simply putting more devices in the hands of store personnel, as opposed to maybe looking at some of the other in-store automation with robots and things like that?

Speaker 1: Yeah. First, I'd say that I don't think that our customers see one solution as being able to solve all problems for them. Deploying more devices or putting more devices in the hands of more associates is clearly a trend and something that our customers see as being able to drive a high ROI and enabling all of them to be connected to their applications and systems and be able to be fully utilized in that respect. With respect to the robot solutions you mentioned also, we believe that there is a good market opportunity for those types of solution in addition to using handheld computers. We have our SmartSight solution for this, and I think that's progressed very nicely since we announced it at NRF this year. We've seen an increase in demand and pilots from many customers, particularly, I would say, here now in the last few months from grocers. I think so far our pilots have proven the technology, we've been able to prove the ROI around just based on labor savings alone. The accuracy of our reads have been very strong. Here is an area where we leveraged our Cortexica acquisition. We've employed a lot of the computer vision technologies from that into SmartSight and to some of our other solutions to accelerate our ability to extract useful information from digital images. We see a good, healthy pipeline of customers who are interested in piloting the solution with us, and we have pilots in North America and Europe at this stage. It's also fair to say that COVID-19 has made it harder for us to engage on customer sites, which is making it a little slower to ramp these pilots up. The interest is as high as it was pre-COVID, I would say. Joe, any further comments from you?

Speaker 7: I'd like to add maybe one thing here. Let's remember, what were the retailers trying to solve with this robotics automation solution? What they're trying to solve is the accuracy of inventory in the store. There are many different capabilities and solutions that solve the inventory accuracy problem in the store. They are suited differently to different types of store formats, as well as merchandise assortments. While we do believe that there is a place for the robotic inventory accuracy improvement, other solutions like RFID or simply using the data from associates' devices, like you can do with Zebra Prescriptive Analytics, are capable solutions for certain store formats and merchandise assortment. The key in our mind will be having the capability to look at all of these different solutions and bring them to a customer. That's what we're going to be in a position to do, including the robotic automation.

Speaker 1: I think that's a good point, just to emphasize again, going back to the first question we had. This is where the breadth of our portfolio enables us to go in and talk to our customers about what is the problem you're trying to solve, and then look at how can we bring our solutions, our technology to bear to best solve the problem they're trying to solve, versus coming in and saying, "Okay, whatever your problem is, my hammer is what's going to solve it." I think this is a great example of how the breadth of our solution plays to our advantage.

Speaker 6: Got it. Thank you for that. Congratulations on the quarter.

Speaker 1: Thank you.

Speaker 12: Our next question will come from Meta Marshall with Morgan Stanley. Please go ahead.

Speaker 9: Great, thanks. Maybe a couple questions from me. One on the Denmark healthcare win. Just any context as to, was that your traditional kind of partner ecosystem that brought you into that deal? Was that a more healthcare-focused partner that brought you in? Then just maybe on the improvement that you're seeing in SMB. Are there any particular geographies or particular type of customer that you're seeing more movement from? Thanks.

Speaker 1: I'll start and then I'll ask Joe to provide some extra color. First on Denmark, the Denmark healthcare win we had. It's a very exciting win for us, and I would say almost uniformly, our healthcare partners are uniquely focused on healthcare. It's very rare that we have partners that are strong in, say, retail or manufacturing and also in healthcare. Those are very different end markets. The solutions are very different, the problems are very different, so it tends to lead to a much more vertically oriented entire value chain for us. Around SMB, we did see improvements in our run rate across all geographies on a sequential basis. I think that this is something we expect that we'll continue to see as the economy recovers into Q4. We've certainly seen a good progression of the run rate and the SMB business here as we get into Q4, but also as we look further into 2021. Joe, any more comments from you? Are you muted, Joe?

Speaker 7: I am. I do apologize. Two comments. On the healthcare partners, one particular type of partner that is very important for us in the healthcare space are the electronic medical records companies. We have excellent relationships with them, both from an ISV and a resale perspective, and that has been a good source of growth for us in the healthcare market. In the SMB segment, the one other one I would call out in particular is China. In China, we've seen a resurgence, I think, of the, in particular, manufacturing customers that are so essential for our printing business. They've certainly contributed to the return of that business.

Speaker 9: Got it. Thanks.

Speaker 12: Our next question will come from Richard Eastman with Baird. Please go ahead.

Speaker 13: Yes. Good morning, and thank you. I guess just wanted to explore the gross margin for a minute here, the adjusted gross margin by segment here. Both segments were down three to 400 basis points. Maybe a little bit surprised around AIT segment being down. So my question maybe is twofold. First of all, around the freight expenses, we're using the term premium freight. Is the freight expense up structurally given the realignment around our subcontract manufacturing base, or is that specifically to the urgency around some of these e-commerce large orders and getting those here? What is that impact?

Speaker 11: Yeah, Rich, I'll take this. I want to start by, I think our teams have been executing well on what we can control around gross margin. If you look at the drivers, it's pretty consistent across both of our segments, both from an unfavorable business mix as well as the premium freight costs. If you look at the more than three points, again, spread between both segments from both large deal mix as well as unfavorable business mix. Just to give an example, in Q3, the mix of large deals was actually greater than what we saw in Q2. Another example, which speaks to the AIT point, if you look at our printer business, it has a larger proportion within run rate and exposure to the manufacturing vertical, along with generally higher gross margin. Another point on premium freight costs, and to answer your question, really it's from capacity constraints, not so much from the change in our manufacturing footprint. We're seeing our cost per kilo up 2x to 3x from what we saw pre-pandemic. Again, just as some of the capacities come offline with reduction in air travel internationally. I think what's important, if you look at the underlying gross margin trends, excluding the mix dynamics, they do remain healthy. As the economy recovers and our run rate business improves, so will gross margin, which you'll begin to see here in Q4.

Speaker 13: AIT has the same, again, large order impact on AIT on the printer side of the business as it does on the MC and scanning?

Speaker 11: What I'd say, it's less reliant on large deals, but it has a higher proportion of run rate business.

Speaker 13: Okay. When you look at, let's move out when things normalize here around the mix of business between the channel and large orders, and then this kind of premium freight starts to dissipate. Are we still kind of at this normalized gross margin level for Zebra that's, let's call it 47% with modest upside? Is that still a normalized gross margin here?

Speaker 11: As we get past the pandemic, we do expect to get back to pre-pandemic levels for both EBITDA rate and gross margin rate. Like I said, the like for like margins remain healthy. We also would expect the vast majority of our OPEX to return as the environment normalizes. I'd say some bit of that will be permanent savings that we'll look to reinvest around the OPEX side. Again, we do expect to get back to the pre-pandemic levels, both in EBITDA and gross margin rate.

Speaker 1: Maybe just add one thing to that. We continue to also develop our portfolio. As you think of the software solutions we talked about here earlier, they tend to come with a higher gross margin, certainly, and as they scale, we would expect them to have a very attractive EBITDA margin too.

Speaker 13: Understood. Yep. Just my second follow-up question, just around the sales and sales channel. Just a quick question. When we look at the Q4 revenue guide of +3% to +7%, is the assumption in there that the channel, both North America as well as Europe, is up year-over-year? Is that assumption in your revenue guide for the Q4?

Speaker 1: Your question was if the channel is expected to be up year-over-year, yeah.

Speaker 13: The channel as in run rate, I'm sorry.

Speaker 1: As in run rate. Yeah. Okay. I'll start here again, and I'll have Joe provide some extra color again. First, we're quite pleased to be able to guide for both top and bottom-line growth year-over-year in Q4 here. The 3%-7% expectation in growth, and that includes 150 basis points of positive impact from Reflexis. First, the large deal activity remains very strong, but the underlying business is recovering faster than expected, and we are also benefiting from some pent-up demand in Q4. As we entered Q4, though, we also had a strong backlog that helped us in this area. The higher large order mix that we've seen compared to prior will continue, but not to the same degree as in Q3. We do expect the run rate and the channel business to continue to sequentially grow. Joe, any more color for you?

Speaker 7: I don't think I have anything to add. You said it.

Speaker 1: Yep.

Speaker 13: Okay. Very good. Thank you for the color. Much appreciated. Fantastic work on the quarter, to be sure.

Speaker 1: Thank you.

Speaker 12: Our next question will come from Brian Drab with William Blair. Please go ahead.

Speaker 4: Hi. At this point, I just have two quick follow-up questions to the recent questions that you were just addressing. I appreciate that gross margin should get back to the pre-pandemic levels. I'm wondering if you could put a finer point on that. Is that something that we could expect in 2021, or does the large Postal Service order maybe weigh on that somewhat in the near term? Is that a longer-term expectation, or is that a 2021 expectation?

Speaker 1: I think it's a little too early for us to give detailed 2021 guidance at this stage, but we do expect that our gross margins will continue to sequentially improve along with the economy and along with the improvement in our run rate business.

Speaker 4: Okay. Anders, you just highlighted also that the software business, of course, should be a tailwind for gross margin as that business grows. With Reflexis, it's obviously a bigger piece of the business. Can you give us any sense for what percentage of revenue now we are at in terms of software? Can you even say if it's more or less than 5%? I know that's not something you've really said in the past, but it's becoming a more meaningful piece, and we don't really know how to model the impact on gross margin without some sense for that.

Speaker 1: Yeah. Obviously, we're very excited about the software business, and our software and services business has been growing quite nicely. The software business as a whole, I think, is still in the single digits for us. It has been growing quite nicely, and we would expect it to be a much bigger part of our business as we go forward.

Speaker 4: Okay. All right. Thank you very much.

Speaker 12: Our next question will come from Keith Housum with Northcoast Research. Please go ahead.

Speaker 8: Good morning, guys, thanks for the question. Nathan, congratulations and welcome to the call. Hey, guys, want to dig in a little bit further into the U.S. Postal Service. Anders, I think I heard you say that the deal is on a pause until late Q1, and then we'll finish up in 3Q of next year. Is the plan still to end, I guess, late summer? I'm just trying to get a little bit more idea on the Q3. In terms of the pause, are we talking the end of the Q1, so don't expect much in the Q1 of 2021 from the U.S. Postal Service?

Speaker 1: Yeah. First, the pause that we now have is a planned activity from USPS. It will start ramping up again in the H2 of the Q1. Q1 will be certainly lower than Q2 and Q3, and we expect that late summer we will be basically wrapping up. We'll continue obviously with other projects and expansions of this project with USPS.

Speaker 8: Great. Thanks. Then just as my follow-up, in terms of the Temptime business, can you just perhaps cover, is there an opportunity with that business to take advantage of perhaps any COVID-19 vaccine that might be out there on the horizon? How is that business doing, and how does that go play here?

Speaker 1: You said Temptime?

Speaker 8: Correct.

Speaker 1: Yeah. Temptime has been doing very well in Q2 and Q3 based on the traditional vaccines that they cover, all the vaccine vials that we cover there. We are working with the WHO and a number of pharmaceutical companies, logistics companies, to ensure that we are well-positioned to provide solutions with respect to COVID vaccine when that becomes available. We have received initial orders from people who are kind of proactively looking to build up an inventory and capabilities for this, but they've been quite small. We expect that that can be a nice addition to the business in 2021.

Speaker 8: Great. Thank you. Good luck.

Speaker 1: Thank you.

Speaker 12: Our next question will come from Blake Gendron with Wolfe Research. Please go ahead.

Speaker 3: Yeah. Hey, thanks. Good morning. I do want to circle back on the deal size evolution here. I know we've been talking a lot about it this morning. If you were to quantify the year-over-year impact of deal mix, in terms of bits or whatever, that would be super helpful. Then, on a scale of one to 10 being pre-pandemic normalized mix versus one being sort of the trough where large deals dominated in the second and Q3, I would imagine, where do you expect the Q4 to be, just because you do anticipate some of the smaller deal size coming back? Then as an offshoot to that, on working capital, you offset some of the receivables friction with payables and things like that. Are the receivables AR, is that impacted by deal size as well, where we should expect maybe a little bit of friction just given the mix?

Speaker 11: Yeah. To answer your first question around the growth we're seeing in both respect to the large and non-large deals. Again, just to clarify, when we say large deals, those are greater than $1 million. In the Q3, the large deals grew over 35%, and our non-large deals were down over 15%. Hard to put a one through 10 classification on it. I would say as we get into Q4, it is going to be slightly higher large order mix than the prior year, but definitely not to the same degree as Q3, and we'd expect that to continue to maybe go back to pre-pandemic levels as we head into 2021, as we see a gradual recovery in the economy. On your last question around AR factoring, I wouldn't say that we've seen any additional friction relative to deal size. It had a modest impact on our year-to-date cash flow, and we'd expect to see a relatively modest impact on our full-year guide.

Speaker 1: Maybe just one more add to this than the prior question. We've had a lot of focus from investors on USPS and the impact USPS has had on our business. U.S. is obviously a large deal, but it was not what drove our Q3 overachievement. USPS came in very much as per our expectations.

Speaker 3: Understood. I appreciate that additional color. A follow-up, if I could, on the regional growth. You broke it out in the slide deck. Looks like North America, Europe, Latin America, kind of trending actually a little bit better than maybe some of our indicators would suggest. APAC was down pretty heavily, maybe more so than other companies have disclosed, at least directionally. On Asia Pacific, first of all, is it a discrepancy, and then is it due to China versus non-China? Is it help of specific end markets or customers? Is there something going on with the channel inventory levels there? I'm just trying to get a better feel for, I guess, the weakness in APAC.

Speaker 1: Well, first, more globally, I'd say what you see globally and also in Asia Pac is some of the secular trends that are supporting our business have accelerated as part of COVID. Around omni-channel, the digitization and automation, those are global trends. In Asia Pac, though, our business has been driven more by, say, a run rate business rather than large deals. The run rate business in manufacturing has been larger parts of our Asia Pac business than in other areas. Specifically in Q3, I think the COVID-19 drove bigger declines in Southeast Asia and India, where good parts of those countries were more or less shut down. That was more impactful for Asia Pac. Asia Pac was up sequentially from Q2, and China actually returned to growth. As I said, we have new leadership in China, a new general manager who's doing a great job there for us. We did also see some relative strength in Australia in Q3.

Speaker 3: That makes sense. Thanks a lot for the time.

Speaker 1: Yep.

Speaker 12: Our next question will come from Andrew Buscaglia with Berenberg. Please go ahead.

Speaker 2: Hey, guys. I just wanted to clarify something on the USPS award. You said you're going to wrap up most of the deal or most of that award by end of Q3, I think. The award was $570 in total or upwards of. I guess, what portion of that will be fully wrapped up? I know there's follow-on stuff that is comprised within that $570 million.

Speaker 1: Yeah, I think, the contract award was up to a maximum of $570 million. I don't think at this stage we can give you, when we break out and say specifically how large the volume for the USPS will be as part of this contract.

Speaker 2: Okay. Also, in your Q4 guide, it was a nice guide, and I think about a third of your sales is EMEA, which didn't quite rebound as much as North America, and now we're starting to see lockdowns again. So I guess, what have you contemplated in that guide? Is it conservative, and does it take into account, kind of what's going on in Europe?

Speaker 1: We feel confident in our sales guide for Q4. It reflects the positive momentum we have in the business. We entered the quarter with strong backlog. We had very healthy levels or lower levels of inventory in the channel. The quarter is actually more front-end loaded than normal. We do see that as giving us great confidence in our guide. There is obviously still continued pressures from COVID and some uncertainty around this. I'd say, though, with specifically to Europe and some of the lockdowns there, that I think if you compare this to April or end of March, when the lockdowns started, I think now companies, most of the lockdowns are intended to be more on aspect of the social life rather than enterprises and business life. I think companies like ourselves, we have learned, I think, how to operate much better in this environment. I would expect that the impact of a lockdown would be less severe now. The lockdown would, again, I think, drive some of the trends that we've talked about around omni-channel, buy online, pickup in store and so forth, which would have some offsetting positive impact for us.

Speaker 2: All right. That's helpful colors . Thanks.

Speaker 1: Thank you.

Speaker 12: Our last question today will come from Jeff Kessler with Imperial Capital. Please go ahead.

Speaker 5: Thank you. When you talk about providing a full, let's call it recurring revenue SaaS type of solution that you're developing going forward, which vertical markets do you think have been most interested in at least talking about how to get to a, if you want to call it a full Zebra solution for them at this point?

Speaker 1: I'm not sure if I can say that any vertical has been more excited about this than others. Maybe I can say, though, that if you look at some of our more recent software acquisitions like Reflexis and Zebra Prescriptive Analytics, or Profitect as it was previously known, the primary vertical markets that they address have been retail. We're probably further along in retail than we are in other markets. As I say, I would highlight healthcare as certainly an industry or a vertical that has a lot of interest in broader solutions and acquiring them as a service.

Speaker 5: Okay. A follow-up, in terms of what types of services and/or technologies might be add on to USPS once you've finished the first part of the contract, would that be instructive for other areas in which you might be able to expand your total available market?

Speaker 1: Yeah, I'm not sure if I want to get ahead of ourselves and talk about what possible business we might win from USPS in the future. USPS is a customer of many of our products already. Printing, scanning, and mobile computing services, some software solutions. I see opportunities for us to engage across a broad suite of solutions. I don't know that I want to highlight any specific ones for you.

Speaker 5: Okay. Just quickly, in that line of thinking on new types of technology, with regard to your mobile scanners, and with the other technologies that you're employing, have you been taking a look at the increase in other types of identifiers such as DOE or NFC, other types of technologies that may be complementary to what you're using right now?

Speaker 1: I guess, the broad answer would be yes. We're certainly looking at all sorts of data capture type of technologies. Our mobile computers, many of them have NFC already. We're always looking to see how we can provide the right type of functionality to enable our customers to get the best ROI for those solutions.

Speaker 7: This is Joe Heel. You might remember that we introduced the proximity monitoring solution that's based on Bluetooth Low Energy, which is built into our devices. NFC technologies, for example, are used in solutions we have for railway ticketing. Those are all technologies we're already using and we think have more potential in the future.

Speaker 5: Okay, great. Thank you very much.

Speaker 12: This will conclude our question and answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks.

Speaker 1: To wrap up, I would just like to thank our employees, customers, and partners who are working the front line during this challenging time. Our team is executing well through the pandemic, and we are proud that our technology solutions are helping enterprises navigating through the challenges of COVID-19 as the world recovers. Stay safe, everyone.

Speaker 12: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.