Q3 2020 Zebra Technologies Corp Earnings Call
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Good day and welcome to the third quarter 2021, Zebra technologies earnings Conference call.
All participants will be in listen only mode should you need assistance, we say more corporate specialists are pressing the star key all base here.
After todays presentation, there will be an opportunity to ask questions. Please.
Please note so that is being recorded.
I would now like to turn the conference over to Mike Steele, Vice President Investor Relations.
Please go ahead.
Good morning, and welcome to Zebras third quarter Conference call. This presentation is being simulcast on our website at investors day, Zebra dot 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 the slide presentation and in today's earnings press release.
Throughout this presentation, unless otherwise indicated our references to sales growth our 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 winners are acting Chief Financial Officer.
Anders will begin with our third quarter results, then Nathan will provide additional detail on the financials and discuss our fourth quarter 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 lets flip to slide four as I turn the call over to Anders.
Thank you Mike.
Good morning, everyone and thank you for joining us.
We are honored that our solutions are empowering frontline workers in the battle against Kobe 19.
I'm proud of our employees, the resiliency and focus on serving our customers critical needs. During these challenging times.
Our top priority continues to be protecting the health and wellbeing of our employees customers and partners.
Businesses continue to progress with their reopening plans.
In Q3, our results continued to be pressured by the global macro environment.
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 the 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 the trends to digitize and automate workflows.
Not surprisingly depend demick 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.
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 would cebra 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 or critical partner attributes cited by this customer and we are proud that our team is delivering to their high standards.
The 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 health care purpose to TC five Sears mobile computers and accessories.
Which will interface seamlessly with their electronic medical health record system.
We have continued to deploy TC seven Sears mobile computers to us PS postal carriers as planned and are now parsing 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 to wait to elevate our role as a solutions provider.
In early September we closed on day reflects this acquisition.
In a few minutes I will 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.
Thank you Anders let's start with the PNM on slide six net.
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 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.
Continued 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 deeper retail solutions.
Location solutions declined from last year due to lower project activity during the pandemic.
We realized six.
Significant sequential improvement in each of our regions from Q2, as we continue to recover from the peak independent.
In North America sales increased 6% most.
Mobile computing and data capture return to solid growth in services continued to perform well.
EMEA 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%.
And that 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 visit 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.
Third quarter adjusted EBITDA margin was 20.3% be.
The 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 16 cents or 5% year over year decrease.
Turning now 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.
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 1.8 times net debt to adjusted EBITDA ratio 0.5 times higher than last quarter.
Due to financing the acquisition of reflects us.
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 three and 7%.
This outlook assumes an approximately 150 basis point additive impact from the acquisition of reflects us 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 reflects us the synergistic with our enterprise asset intelligence vision as well as trends in our end markets.
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 by leveraging real time data to gain actionable insights.
We are excited to have it affects us onboard which further helps see bring our enterprise price asset intelligence vision to life for retailers and other end markets.
Reflects is that demonstrated leader in intelligent workforce management and task execution.
Our platform is utilized by hundreds of retailers around the globe to drive employee productivity and retention, while also improving customer engagement.
With Texas is synergistic with our existing suite of solutions as a service.
As you can see on slide 12. These include smart count, which is an innovative self scan and physical inventory management solution.
Our smartside robotic solution, which uses automated intelligence to help identify issues on the store shelf in real time.
Our workforce connected data and voice communication and collaboration uptight application for mobile workers.
And Cebra prescriptive analytics, which provides data driven insights and a prioritized list of prescriptive actions that help maximize efficiency and reduce shrinkage.
The breast suite of solutions work in unison with our product portfolio to provide real time contextual tasking. This.
This capability is critical for successfully addressing the inevitable unplanned events that occur throughout their workday.
Over the next few quarters, we will continue to invest in the seamless integration over Texas 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 impact. 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 that 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 assuming.
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 continued to make health care 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 depend demick.
We have also begun to resume business with many department stores and specialty retailers that have been re opening their doors.
In the transportation and logistics space strong E Commerce growth continues to drive partial volumes and last mile delivery, which is favorable to cebra.
Passenger airlines rental car providers and other related businesses remained challenged.
The manufacturing sector continues to be most impacted would koby 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 depend demick.
We've seen mixed trends in discrete manufacturing, we dose in aviation and discretionary specialty goods, particularly challenged.
The 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 sebra 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. Thanks.
Thanks, Anders will now open the call. The culinary 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.
Well now begin the question answer session.
Ask your question you May Press Star then one on your Touchtone.
I'm curious on speakerphone, please pick up your handset before pressing the keys.
So your question. Please press Star then two at.
At this time, we'll pause momentarily to assemble our roster.
Our first question will come from Tom the mole with Stephens.
Hey, Scott.
Good morning, and thanks for taking my questions.
All right. Good morning, Sir your line is open.
Anders I wanted to start on the reflects this deal.
Could you articulate for us how important.
Integrating software as part of your revenue mix will be going forward and what.
What are some of the strategic rationale so 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.
Zebra and and then as it related point.
As you do head into more software driven sales.
Should we think about that market is one that's more competitive than where youve traditionally competed or how how do you want to frame up the competitive dynamics there. Thank you.
Yeah, that's good I'll I'll start and then I'll ask Joe heel to to help out also.
Your first just.
Yes.
Reflects is is a great company. We are very excited that it's part of our portfolio part of the Cebra family here now it's been demonstrated leader intelligent workforce management, then task execution port for many years and its been deployed by hundreds of retailers around the globe to help drive employee productivity and retention and many many of those.
Customers are common to zebra and to also to our Cebra prescriptive analytic analytics solution. So when we look at.
Reflects this and see about prescriptive analytics and other software solutions, we have we see them as being very synergistic with our overall solution.
If you think about our framework around sense analyze and act I think thats, probably the easiest way maybe to to show how we how we think about creating a more complete solutions for our customers, but we have had the historically a.
Great strength around a sense and summing to analyze park, but being able to sense, what's happening the physical world has been kind of our our our foundation, but over the last few years, we have expanded our our capabilities around to analyze and act side quite a bit and both see about prescriptive analytics and and reflect.
This are examples of that and now when we.
When we.
Prior to actually the acquisition of reflects is we had a number of customers ask us to do more tight integration between the zebra prescriptive analytics and reflects this they felt that that will be something that would would help get more value out of those investments.
See about prescriptive analytics can and continue to feed actions into reflects this action engine to help combat combine all the different actions that the retail might do and prioritize way and then we can leverage our other.
Software assets like workforce connect to be able to let you know tight back into our mobile computers.
Well our hour.
Store associates can either you know scan.
Items in the store or enter other data that can be fed into zepa or into a flexible but also then be receiving updates or actions from that so thats. The direct effects the system can deliver even greater value by being able to do that.
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And for foreseeable as a whole with or.
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 and by that we can increase the ROI of our overall solutions and B.
A more strategic thought partner as they think about how they develop their business. So 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.
Perhaps I'll underlying two things you touched on one is the fact that we are synergistic not just on the product level.
Andrew This highlights how we think we can bring together the different product capabilities, we have but certainly also on their go to market and sales level, where we have a very strong share in the retail market already and bringing reflexes to those retail customers is an immediate cross sell opportunity that we have we're actually discuss.
Spring that it also works the other way around that reflects this has some customers.
That.
Can bring us into and cross sell that way and that leads into the strategic opportunity that I understood right right, which is reflects this generally has a strong presence in the operation side of retailers and this now gives us an opportunity to solve their problems strategically and perhaps also addresses.
The second part of your question around him do we see this is you know more competitive space and certainly.
Certainly there are different competitors in a in the pure work flow software area. However, none of them have the capability that we have to bring together the sense analyze act as part of the eye vision and to solve the problem Holistically. So we look at this as a space, where we can differentiate ourselves actually.
From both the traditional competitors that we have and the competitors at the success from.
Yeah, just to round out say I've been on the phone weird.
Many of the largest customer solve reflects this over the last month or two and I'd say that is uniformly. They they are very excited about the combination they are passionate about their effects is.
Solution, but they also see the value that the combination with zebra and the extra resources, we can have and how our vision for how we can continue to add value to their operations. So I think so far it's been a great great feedback from that from the market and from our customers.
Thank you. Thank you all that 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 there.
Their plans.
For the omni channel.
Integration, it or leaning into their ecommerce platforms.
So to two related questions.
How durable do you see that trend being it or or maybe you could frame up.
Qualitatively if not quantitatively how far ahead do you think your current backlog gives you.
Visibility into maintaining a robust pace of sales and then.
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 suggest that maybe the playing field here has expanded if you just look around the retail landscape. There are a lot more engaged and omni channel are talking about it at least now and there were a year ago. So I just wonder if maybe there's a tail.
Dan aspect to this dynamic as well where its shifted in your favor. Thank you.
Yes, well 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 critical for our customers.
We are I would say is uniquely positioned to empower frontline workers across all our vertical end markets and koby 19 has been accelerating a number of secular trends around digitization and automation and this probably most apparent in retail around E commerce.
Around.
Omni channel and byline pick up at store.
Here, we have seen particularly around <unk> mass merchants grocers and E. Tailers that they have been the most of the quickest I guess to pick up on this into and Thats about two thirds of our of our business.
But I'd say.
Yes, yes the.
The largest retailers have been the.
Mostly been been the most aggressive or the earliest to start adopting an investing around in solutions around omni channel and E Commerce.
They have seen a great growth in there.
Omnichannel.
And buy online pickup at store businesses and they have still believe that there is lots of market share that they can continue to grow.
And takes so they are continuing to invest heavily in building out the capabilities and scaling their capabilities compared to where it was say just six months back.
For smaller retailers they say.
Hey, Jim.
Generalizing a bit now they were maybe not quite as quick to end.
Invest in Omnichannel capabilities, it's a big investment and a complicated one at times, but I think the.
The Cobi 19, and the changes in.
A customer buying behaviors and the step up in in a change in how comfortable consumers are with Omnichannel end to end to buy online pickup at store to say as an example has made its I think abundantly clear for smaller retailers to that if they want to compete they need to build these types of capabilities.
So we see the.
Pipeline of business around.
No these larger trends around digitization automation and particularly in retail as compares quite robust and we think that this is a trend that will be.
Going on for quite some time.
And Thats, a joke and would say im just saying that I think for for now we see the then the pipelines of these types of opportunities as we look into 2021 as being as robust as we would have expected them to be in prior year. So this time.
Joe.
Yeah, I'll add perhaps.
Two thoughts.
I do think Theres and every that Tam expansion thats going on but 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.
Although these omni channel capabilities needed deep capability in the company more broadly than just.
At the front, where the the items are being picked up things in particular that you need to do that I think favor us and this case is number one you need an equal your associate.
Your associates in your store, because that's where most of the instant omni channel capabilities being created and that means you need to digitize every worker a device in some form and we're far from that today. So that's it seems that the Tam expansion and the second piece is you need to extend that.
Modernization into your supply chain and debt, we're seeing a lot of activity in terms of ER digitizing and automating the supply chain.
And.
Thats is clearly related to this acceleration of the cars.
Great. Thank you all I will turn it back appreciate it.
Our next question comes from Jim Ricchiuti with Needham and company. Please go ahead.
To follow up on that some of the less commentary that you are making Anders.
Sounds like you're still anticipating a fairly robust.
With your larger customers. So it's not as a potentially there's some digestion from the investments that they make and then as it relates to the small medium.
Segment of more I wasn't sure if you yeah. So.
To what extent you are seeing.
A recovery there I mean is there the potential over the next one to two quarters that you could have both areas of the business, but large accounts and the SMB.
Right.
Actually moving and in a consistent fashion toward stronger growth.
Yes, Firstly I think we're seeing faster than expected improvement in our end markets and we are cautiously optimistic about the comment how the economy will recover into two 2020, one I think here our industry leadership and our investments in our business will also enable us to rebound stronger than our comps.
Jitters and.
To that point, so thats why we feel confident to guide for.
Both the top and bottom line growth in Q4.
When we looked at our Q3 performance here our run rate.
It's improving it's not back to cope with 90, prequalified 19 levels, but it is definitely improving and strengthening.
And I think that was something we sold globally.
And our large deals deals were obviously very strong in Q3, but we still have a good pipeline into our larger customers and how they are looking to invest in Q4 and beyond.
Joe do you want to add anything to this also.
Perhaps 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. So we have a strong pipeline that gives us the confidence and our run rate has been recovering.
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.
Got it and just as a follow up question.
This relates more to some reports that we began to see including one by a large retailer that had been considering deploying in store robots for inventory analysis and has now pull back it apparently on that initiative and I know you guys.
We have looked at that market, but I guess my question is.
But the opportunity is there does it appear that it looks like.
Some of the major retailers may opt for simply putting more debt by expenses 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.
Yes, first I'd say that they I don't think that the customers see one solution as being able to solve all problems for them.
Deploying more and more.
More devices are putting more devices in the hands of more associates is clearly a trend and something that the.
Our customers see us 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 fully utilized in that respect.
With respect to the.
[noise] robots solutions you mentioned also we believe that there is a.
A good market opportunity for those types of solutions. In addition to using handheld computers, we have our smartside solution for this and I think thats progressed very nicely since we announced it in.
Then our EPS this year, we've seen a demand increase in demand and and pilots from from any customers, particularly I would say here now in the last few months from grocers.
I think so far our pilots have.
Proven the technology and we have been moved to prove the the ROI around just based on labor savings alone.
And the accuracy of our of our reads have been very strong.
And we will be here is an area, where we leveraged.
Our Alco cortex together acquisition. So we've improved employed a lot of the computer vision technologies from that into.
Smartside into some of our other solutions to accelerate our ability to extract useful information from digital images. So we see.
A good healthy pipeline of customers, who are interested in piloting. So this solution with us and we have pilots in North America and Europe at that at this stage.
Although it's also fair to say that we.
No.
COVID-19 has made it harder for us to engage on customer sites.
Which is making it a little slower to ramp these pilots out but they didn't interest is as high as it was a pre cobot I would say.
Joe any further comments from you.
And I'd like to add maybe one thing here.
Let's remember what where the retailers trying to solve with this robotics automation.
Solution, what they're trying to solve is the accuracy of inventory in the store and there are many different capabilities and solutions that solve the inventory accuracy, probably more and they they are suited differently to different types of store format.
As well as merchandise Assortments and wild.
While we do believe that there is a place for the robotic inventory accuracy improvement other solutions like our I'd or simply using the data from associates devices like you can do with.
Deeper prescriptive analytics are capable solutions for certain store formats and merchandise assortment. So the key in our minds will be having the capability to look at all of these different solutions and bring them to a customer and that's what we're going to be in a position to do including the robot.
Yes, I think Thats a good point just on on on took to emphasize again from the going back to the first question we had this.
This is where the breadth of our portfolio enables us to go away and then talk to our customers about what is the problem. You are trying to solve and then look at how can we bring our solutions our technology to bear to best solve the problem. They are trying to solve versus coming in and saying, Okay. I have a whatever your problem is my hammary is whats going to solve it.
So I think this is a great example of how that how the breadth of our solution plays to our advantage.
Got it thank you for that congratulations on the quarter. Thank you.
Our next question will come from meta Marshall with Morgan Stanley. Please go ahead.
Great. Thanks.
Maybe a couple of questions for me one on the Denmark health care when just any context as to what was that your traditional kind of partner ecosystem that brought you into that deal.
It was that have more health care focus partner that brought you in and then just maybe on the improvement that you're seeing in SMB and are there any particular geography is there a particular type of customer that you're seeing more movement from thanks.
Yes, again, I'll start and then I'll ask Joe to provide some extra color.
So first on on Denmark, the Denmar healthcare win we had in this very exciting win for us and.
I would say almost uniformly.
Our health care partners are uniquely focused on health care is very rare that we have partners that are strong in say retail or manufacturing and also in healthcare. The 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 the entire value chain for for us.
Then around SMB, we did see improvements in our run rate across all geographies on a sequential basis.
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I think that the this is.
Something we expect to there will continue to see SD economy recovers.
Into Q4, Weve certainly seen good.
Good.
Good progression of the run rate than the SMB business here as we get into Q4, but also as we look further into keys Twentytwenty one.
Joe any more comments for you.
Well you'd muted job.
I am I do apologize.
Yes, two comments on the healthcare partners. One particular type of partner that is very important for us to health care sales R&D electronic medical records companies.
We have excellent relationships with them, both from an I.S.D. and resale perspective, and that's been a good source of growth for us.
In health care market.
In the SMB segment. The one other one I would call out any particular is them.
It's China, so in China, we've seen.
Resurgence I think of the in particular manufacturing customers that are so essential for our printing business and.
And they contributed to the returns.
Right. Thanks.
Our next question will come from Richard is that fair.
Hey, Scott.
Yes, good morning, and thank you.
Yes, just wanted to explore the gross margin for a minute here the adjusted gross margin.
By segments here.
Both both segments were down three to 400 basis points.
Maybe a little bit surprised around E T.
Segment being down.
So so my question maybe is twofold I mean first of all around.
The freight expenses.
We are using the term premium freight it's.
It's just the freight expense up structurally given the realignment around our subcontract manufacturing base or is that you know specifically to the urgency around some of the E commerce large orders in getting those here.
What does what does that impact.
Rich so I'll take this.
I want to start by I think our teams have been executing well what we can control around gross margin and if you look at the drivers it's pretty consistent across both of our segments both.
Both from an unfavorable business mix as well as the premium freight costs.
And if you look at the.
One of the three points and again kind of spread between both both segments from both large deal mix as well as unfavorable business mix just to get an example in Q3 the mix of large deals was actually greater than what we saw in Q2.
Another example, which speaks to the to the 18 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.
And then another.
Another point on premium freight costs and to answer your question right.
Really it's from capacity constraints not so much from the change in our manufacturing footprint and we're seeing our cost per kilo up two to three X from what we saw pre pandemic again, just as some of the capacities come offline with reduction in air travel internationally.
And I think what's important if you look at the underlying gross margin trends, excluding the mixed dynamics, they do remain healthy and as the economy recovers and our run rate business improves so gross margin, which you will begin to see here in Q4.
Mhm and AI key his claim.
Again large order impact on AI tea on the printer side of the business as it does on the you know the MC and scanning.
Well I'd say, it's less reliant on large deals, but it has a higher proportion within the run rate.
Higher proportion of run rate business okay.
Okay, and when you look at let's move out when things normalize year around.
Around the mix of business between the channel and large large orders and then there's kind.
Kind of this freight this premium rate starts to dissipate are we still kind of at this normalized gross margin level for zebra. This.
Paul at 47% with you know with modest upside.
Is that still a normalized gross margin here.
Yes, so as we get past the pandemic, we do expect to get back to pre pandemic levels for both EBITDA rate and gross margin rate and 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 and.
We have to use I'd say some bit of that will be permanent savings that we'll look to reinvest around the opex side, but again, we we do get we do expect to get back to the pre pandemic levels, both in EBITDA and gross margin rate.
Yeah, maybe just to add one thing to that now.
We continue to also develop our portfolio. So as you think about the software solutions, we talked about here earlier data.
They tend to come with a higher gross margin certainly and as they scale that we would expect them to have a very attractive EBITDA margin too.
Understood.
And then just my second my second follow up question just around the sales and sales channels. Just just a quick question. When we look at the fourth quarter revenue guidance plus three to plus Darling.
Yes, the assumption in there that the channel or.
North America as well as Europe is up year over year was that assumption in your guide revenue guide for the fourth quarter.
So your question was if if the channel is expected to be up.
Yes, so analytics run rate I'm, sorry, that's in run rate yeah. Okay. So yes.
I'll, let Alan I'll start here again, and I'll have Joe.
To provide some extra color again, but you know first of all we were quite pleased to be able to guide for both the top and bottom line growth year over year EPS in Q4 here, but the 3% to 3% to 7% the expectation in growth and that includes 150 basis points of positive impact from reflects this.
First on the large deal activity remains very strong, but the underlying business is recovering faster than expected and we are also benefiting from some some.
Pent up demand in Q4.
As we entered Q4, though we also had a strong backlog that that helped us.
In this area the.
The higher large order mix than what we have seen compared to prior year will continue but not to the same degree EPS in Q3. So we do expect the the run rate than the channel business to continue to to sequentially grow and Joe.
Joe Denny anymore color for you.
I don't think anything Cat you said yep.
Okay very good. Thank you for the color much appreciated and then.
Yes at work on the quarter to be sure. Thank you.
Our next question, probably trumps, Brian drab with William Blair. Please go ahead is yours.
Hi at this point I guess so.
Two quick follow up question to the the recent questions that you're just addressing so.
I appreciate that gross margin should get back to the pre pandemic level.
A margin could put a finer.
Point on that is that something that we can expect in 2021 or does the large.
Postal service order, maybe weigh on that Oh.
Somewhat in the near term is that a longer term expectation or is that a 20 2021 expectation.
I think it's a little too early for us to give 22 and our 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.
Okay, and then I understand just highlighted also that the software business of course should be a tailwind for gross margin.
As that business grows and with reflects assets.
Obviously, a bigger piece of business can can you.
Give us any sense for how.
What percentage of revenue now we are at in terms of software isn't it.
Can you can take that more or less than 5% I know, it's not something you really said in the past, but it's becoming a more meaningful piece. Then we don't really know how to model the impact on gross margin without some sense for that.
Yes. The obviously, we are very excited about the softer business and our software and services business has been.
Growth growing quite a quite quite nicely.
The software business as a whole I think is still in the single digits for us but.
It's been as it has been growing quite quite nicely and.
We would.
Expect it to be to be a.
A much bigger part of our business as we go forward.
Okay.
All right. Thank you very much.
Our next question will come from Keith Housum with.
First research. Please go ahead.
Good morning, guys and thanks for the question and they've been congratulations and welcome to the call.
Hey, guys one of the deal it ticking a little bit further into the U.S postal service and as I think I heard you say that the deals on a pause until late first quarter and on a milk finish up in Threeq here next year. So is the plan still to end I guess late summer I'm, just trying to get a bit more idea third quarter in terms of the pause are we talking.
We ended the first quarter. So don't expect much in the first quarter 21 from U.S Postal service.
Yeah first did the the pasta. We now have is a planned activity from from U.S. past. This was always their intent to not deploy new devices. During during kind of the peak season, and it will start ramping up again in the second half of the first quarter. So the it was for Q1 will be less certain.
Lower than Q2, and Q3, and we expect that late summer, we will be basically wrapping up.
And then we will continue obviously with other projects and expansions of this project with Usbs.
Great. Thanks, and then just as my follow up in terms of liquid sometime business.
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 it how that could play here.
So you said 10 time correct.
Yes, so Tim attempt on has been doing very well in Q2 and Q3 based on the traditional vaccines that they covered all the vaccine bias that we cover there. We we are working with the WH, Ohio, and a number of pharmaceutical companies logistics companies.
To ensure that we are well positioned to provide solutions with respect to cope with the coated vaccine when that becomes available. We have received the initial orders from people who are.
Proactively.
Looking to to build up the inventory and l. capabilities for for this but they have been quite small, but we expect that that can be a nice addition to the business incurred in 2021.
Great. Thank you good luck.
Thank you.
Our next question will come from Blake Gendron with Wolfe Research. Please go ahead.
Hey, Thanks, Good morning, I do want to circle back on the deal size evolution here I know we've been talking about it this morning.
But if you were to quantify the year over year impact of your mix.
In terms of bips or or whatever that would be super helpful. And then you want to scale of one to 10 10 being pre pandemic normalized mix versus one being sort of the trough where large deals dominated in the in the second and third quarter I would imagine where do you expect the fourth quarter to be I'd, just because you do anticipate some of the smaller deal size coming back.
And then as an offshoot to that I'm working capital you off that some of the receivables friction with payables and things like that or the receivables. They are is that impacted by deal size as well, where we should expect maybe a little bit of friction just given given the mix.
Yes, so to answer your first question around the the growth we're seeing in both respect to the large and non large deals. So again just to clarify when we say large deals those are greater than a million in the third quarter. The large sales grew over 35% and our non large deals were down over 15%.
And Thats hard to put a one through 10 classification on 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.
And your last question around HR factoring.
Yeah, 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 expect to see a relatively modest impact on our full year guide.
Maybe just one to one book.
Add to this than the prior question. So we've had a lot of focus on the.
From investors on you Sps and the impact of the have you assess it had on our business and you asked is obviously a large deal but it was not what drove our our Q3 over achievement.
Usbs came in very much as per our expectations.
Understood I appreciate that additional color on that and then a follow up if I could on the regional growth you broke it out in the slide deck, Let's say North America, Europe, Latin America kind of trending actually a little bit better than maybe some offer indicators would suggest APAC was down pretty heavily maybe more so than.
And then other companies have had disclosed at least directionally. So on Asia Pacific is the issue there just.
Of all is that a discrepancy and then is it due to China versus non China does it help us 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 a pack.
Well first the more more globally I say, you know what what to see globally and and also in Asia. Pac is somebody is the secular trends that are supporting our business have accelerated as part of covert so around omni channel the digitization and automation those are all that those are global.
Global trends.
And.
In Asia Pac, though we have.
Our business has been driven more by say a run rate business rather than large deals. So the run rate business and manufacturing has been.
Large larger parts of our Asia Pac business, then than in other areas and specifically in Q3, I think the Cobi 19 drove bigger declines in southeast Asia, and and India were.
Good parts of those countries for more or less shutdown. So that that was more more impactful for.
For Asia Pac, but Asia Pac was up.
From from sequentially from Q2, and China actually returned to growth and as I said, we have we have new leadership in China, a new general manager Who's Who's doing great job there.
For US we we did also see some relative strength in Australia in Q3.
That makes sense. Thanks, a lot for the time.
Yes.
Our next question will come from Hampshire, Scalia with Aaron Berg. Please go ahead.
Hey, guys I, just wanted to clarify something on the U.S.P.S.
Award.
So you said you're going to wrap up most of the deal or most of that award by the end of Q3 I think.
The deal was there. They award was 570 in total are up upwards of.
Yes.
What portion of that you know will be fully wrapped up because I know there is follow on stuff that is comprised within that $70 million.
Yes, I think the contract award was up to a maximum of 570 $570 million.
Don't think at this stage, we can give you is when you break it break out than say, specifically, how largely count as the.
The volume for the Usbs will be as part of this contract.
Okay.
Okay.
Also.
And your your Q4 guide to was that it was a nice guide and now that I think about a 30 year sales is is the FDA.
Which we didn't quite rebound as much as North America and now we're starting to see Lockdowns again, so I guess.
What what have you contemplated in that guidance is that conservative and does that take into account.
What's going on in Europe.
So we feel confident in our sales guide for Q4. It reflects the positive momentum we have in the business.
We ended the quarter with Wade.
Strong backlog.
We had very healthy level, so lower levels of inventory in the channel. So the quarters actually more front end loaded than than normal. So we do see.
That us as giving us great confidence in our guide.
But there is obviously still continued pressures from from Covidien and some uncertainty around this.
I would say, though we had specific to Europe and somewhat locked down there that I think if you compare this to April when or end of March when the Lockdown started I think now companies most of the first most of the.
The lockdown so are intended to be more on the on EPS on aspect of the social social life, rather than than enterprises and business life and I think companies like ourselves. We have learned I think how to operate much better in them.
In this environment. So I would expect that the impact of a lockdown would be less severe now and.
The Lockdown would again I think drive some of the trends that we've talked about around omni channel bile and pickup in store and so forth, which would have some offsetting positive impact for us.
All right that's helpful color. Thanks, Thank you.
Okay.
Our last question today will come from Jeff Kessler with Imperial capital. Please go ahead. Thank.
Thank you.
What.
And when you talk about when you talk about providing a full.
Let's call it recurring revenue SaaS type of solution.
That that that you're developing going forward.
Which vertical markets.
Have been.
Which vertical markets do you think has 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.
I.
I'm not sure if I can say that the any vertical has more been more excited about this than than others.
Maybe I can say, though that they are if you look at some of our.
More recent software acquisitions like reflects this and the zebra prescriptive analytics or profit pick the sales previously known.
The.
Primary vertical markets that they address had been retail so we probably further along in retail than we are in other markets, but I would say I would highlight the healthcare is certainly an industry or vertical that has a lot of interest in.
Broader solutions and acquiring them as a service.
Okay.
And a follow up in terms of.
What types of what types of of services, Ed or technologies, a might be add on to U.S.P.S. Once you've done the first part of the.
Once you've done the first finished the first part of the contract.
Would that be instructive for other you know.
For for other areas in which.
In which you might be able to expand your total available market.
Yes, Im not sure if I want to get ahead of ourselves and.
Talk about whats possible business, we might win from you Sps in the future.
You Sps is a customer of many of our diet products already so printing scanning and mobile computing.
Services, some softer solutions.
So I I.
I see opportunities for us to engage across a broad suite.
Suite of solutions, but I don't know that I want to highlight any specific ones for you okay.
Okay and just quickly.
And in that line of thinking on new types of technology.
With regard to your remote your mobile scanners.
And with the with the other technologies that you're employing have you been taking a look at the increase in.
In other types of I'd identifier such as such.
Such as video he or NFC.
Oh, the other types of technologies that may be complimentary to what you are using right now.
So.
I guess, the you know the broad answer will be yes, we certainly looking at all sorts of data capture type of technologies and our mobile computers many of them have NFC already so.
We're always looking to see how we can.
Quite the right type of functionality to enable our customers to get the best ROI portfolio for those solutions.
Yes, Mike It's Joe you might remember that we introduced the proximity monitoring solution. That's based on Bluetooth low energy, which is built into our devices and.
NFC technologies for example are used in solutions, we have for railway ticketing and so those are all technologies were already using and we think have more potential in the future.
Great. Thank you very much.
Well spoken include our question and answer session I would like to turn the conference back over to Mr. workers Simpson for any closing remarks.
To wrap up I would just like to thank our employees customers and partners, who are working to frontline. During this challenging time, our team is executing well through depend dynamic and we are proud that our technology solutions are helping enterprises navigating through the challenges of koby 19, as the world recovers.
Stay safe everyone.
The conference has now concluded.
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