Zebra Technologies Corporation

Good day and welcome to the first quarter 2021 Zebra Technologies earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note, this event 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 Zebra's first quarter 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 Chief Financial Officer. Anders will begin with our first quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2021 outlook. Anders will conclude with progress made on advancing our enterprise asset intelligence vision. Following the prepared remarks, Joe Heal, our Chief Revenue Officer, will join us as we take your questions. Now let's flip to slide four as I turn the call over to Anders. Thank you, Mike.

Good morning, everyone, and thank you for joining us. Our team delivered exceptional first quarter results with strong performance across the business, resulting in record sales and profits. For the quarter, we realized adjusted net sales growth of 28% or 25% on an organic basis, an adjusted EBITDA margin of 25.3%, a 620 basis point year-over-year improvement, non-GAAP diluted earnings per share of $4.79, a 79% increase from the prior year, and strong free cash flow. Our teams executed well to satisfy a stronger-than-expected recovery in demand from smaller customers through our distribution channel and continued strong demand from large customers to digitize and automate their workflows in an increasingly on-demand economy. We realized strong broad-based demand with double-digit sales growth across our four regions, each major product and solutions category, as well as in all of our vertical end markets. We also significantly expanded profit margins, driven by favorable business mix and lower travel expenses. while at the same time we continued to invest in initiatives to drive sustainable, profitable growth. Given our momentum and pace of innovation, we are increasingly confident in our growth prospects. With that, I will now turn the call over to Nathan to review our Q1 financial results in more detail and discuss our improved 2021 outlook.

Thank you, Anders. Let's start with the P&L on slide six. In Q1, Adjusted net sales increased 28.3%, including the impact of currency and the Reflexus acquisition, and 25% on an organic basis, reflecting broad-based demand for our solutions. Direct sales to large customers grew double digits, and we saw even higher growth from smaller customers through the channel, partially driven by pent-up demand. Our asset intelligence and tracking segment, including printing and supplies, grew 21.4%, while enterprise visibility and mobility segment sales increased 26.8%, driven by exceptional growth in enterprise mobile computing. We realized strong double-digit growth in services and software and also had strong growth in our RFID solutions, which is beginning to rebound from the depths of the pandemic. We recognized double-digit growth in all regions. In North America, sales increased 28%, with mobile computing, printing, services, and supplies each growing double digits. In EMEA, sales increased 22%, with solid growth across all subregions and solutions offerings. APAC returned to growth, with sales up 19%, led by strength in China, Australia, New Zealand, and India. Latin America also returned to growth in all subregions, with sales increasing 31%. Adjusted gross margin expanded 370 basis points to 48.9%, primarily driven by favorable business mix and higher service and software margin. The favorable year-on-year impact from China tariffs was offset by $11 million of incremental premium freight charges. Adjusted operating expenses as a percentage of sales improved 280 basis points. We have been accelerating high return investments in the business while prudently managing discretionary costs. First quarter adjusted EBITDA margin was 25.3%, a 620 basis point increase from the prior year period, reflecting higher gross margin and operating expense leverage. We drove non-GAAP earnings per diluted share of $4.79, a $2.12, or 79.4% year-over-year increase. EPS growth also benefited from lower interest expense and a lower share count, partially offset by a slightly higher tax rate. Now turning to the balance sheet and cash flow highlights on slide 7. We generated $214 million of free cash flow in Q1. This was $119 million higher than the prior year, primarily due to increased profitable growth. In Q1, we had $13 million of venture investments in two companies that provide real-time asset visibility and artificial intelligence solutions. Our balance sheet remains strong. From a debt leverage perspective, we ended Q1 at a modest 0.9 times net debt to adjusted EBITDA leverage ratio. Let's now turn to our outlook. We entered Q2 with a strong order backlog and healthy channel inventory levels. We are encouraged by the broad-based, robust demand we are seeing across virtually every dimension of our business, as customers step up their plans to invest in digital transformation. This momentum, along with our sales pipeline, gives us the confidence to provide a strong Q2 guide and to substantially raise our full-year outlook. In Q2, we expect adjusted net sales to increase between 38% and 42%. This outlook assumes a 450% 500 basis point additive impact from the acquisition of Reflexus and foreign currency changes. We anticipate Q2 adjusted EBITDA margin to be between 21% and 22%, which assumes gross margin expansion and operating expense leverage. It also assumes approximately $18 million of premium freight expense, which is roughly the same gross profit impact we realized in Q2 2020 from the combination of premium freight, COVID mitigation, and China tariff impacts. Non-GAAP diluted EPS is expected to be in the range of $4 to $4.20. For the full year 2021, we are raising our guide for adjusted net sales growth to be between 18% and 22%, which reflects our increasing optimism for solid growth in the second half of the year, despite supply chain constraints from certain product components. This outlook assumes an approximately three percentage point additive impact from the acquisition of Reflexus and foreign currency changes. We have raised our expectation of full year 2021 adjusted EBITDA margin to be between 22 and 23%, which assumes operating expense leverage and meaningful gross margin expansion from the prior year, despite an expectation for premium freight charges of 50 to $60 million as we work to mitigate global supply chain challenges. We now expect free cash flow to be at least $850 million for the year due to our revised outlook for increased profitable growth. Please reference additional modeling assumptions shown on slide eight. With that, I'll turn the call back to Anders to discuss how we're advancing our enterprise asset intelligence vision in the markets we serve.

Thank you, Nathan. I am encouraged by the strengthening demand across our business, which allows us to increase our 2021 outlook. Our team has done an outstanding job navigating us through the pandemic. Slide 10 illustrates how we are working with our customers and partners to advance our enterprise asset intelligence vision. By leveraging Zebra's leading portfolio of products, solutions, software, and services, our customers can overcome some of their most complex operational challenges and transform their frontline workflows to achieve higher levels of performance. Businesses across all industries are adopting solutions that digitize and automate their operations at the edge to help them compete more effectively in today's increasingly on-demand economy. With our innovative solutions, our customers' frontline associates can now anticipate and react in near real time. utilizing insights driven by advanced software capabilities such as machine learning, prescriptive analytics, and computer vision. We have been making solid progress integrating reflexes, market-leading workforce management, and real-time task management solutions with our existing software applications to optimize the experience for frontline workers, as well as reduce complexity for the corporate teams that support them. Our value proposition is to ensure the best next action for every worker is easily identified, assigned, and completed, leveraging artificial intelligence gathered from real-time inventory or point-of-sale data. We are receiving very positive feedback from customers on the software portfolio enhancements we have planned for this year that will enable a unified experience across labor planning, tasking, and workforce communications. We also continue to invest to accelerate the go-to-market traction of our growing suite of solutions. Slide 11 highlights how the pandemic has accelerated trends that have been driving our business. Consumers have been raising their service-level expectations in this on-demand economy. Enterprises are investing in Zebra solutions with an increased sense of urgency due to a significant increase in omnichannel shopping. forecasts for global e-commerce sales and parcel shipping volumes to double over the next several years, track and trace becoming increasingly important for a wide range of use cases, and healthcare patients seeking a more digital experience. Automating strained workflows with proven technology provides an attractive return on investment. The benefits to the enterprise also include increased productivity and efficiency, as well as higher customer and patient satisfaction. These opportunities are not exclusive to large enterprise customers, as we are seeing similar trends with small and medium-sized businesses. To capitalize on the favorable e-commerce trends I just mentioned, yesterday we announced the launch of Zebra's first cloud-connected label printer designed specifically for the small business home office customer, featuring eco-friendly cartridges and mobile application software to easily design and print labels from anywhere. With the launch of the ZSB series printer, we enter an approximately $400 million market with an attractive recurring supplies revenue stream. We have been innovating at a record pace despite the pandemic, and this Soho label printing offering is a proof point of our focus on expanding into attractive adjacent markets where we can provide a differentiated offering. Now turning to slide 12. We understand the operational challenges our customers face in the increasingly on-demand economy. As a trusted strategic partner, businesses of all sizes in a variety of end markets turn to Zebra to help optimize end-to-end workflows. In retail, there's been a sharp increase in omnichannel and online shopping. To retain business, retailers need to deliver goods in a timely manner or make them available for pickup when promised. To address this challenge, a wide range of retailers have been prioritizing investment in Zebra solutions that provide higher inventory accuracy and utilize their labor more effectively. For example, a leading UK supermarket chain recently purchased over 5,000 Zebra ZQ610 mobile printers. nearly 1,400 stores and added thousands more TC52s, TC77s and PS20s for their existing Zebra fleet of devices to enable inventory management, omni-channel fulfillment and other critical use cases across their operations. They are also evaluating Zebra's workforce management and scheduling software applications for use across all their stores. Additionally, We have received very positive feedback from a large fashion accessories retail customer who has adopted our new option for Zebra prescriptive analytics to feed directly into our Reflexis workforce and task management software offering. Other retail customers are planning to adopt this capability soon to leverage the synergistic benefits. In transportation and logistics, strong e-commerce adoption continues to drive exponential growth in parcel volumes, putting pressure on supply chains even as they hire more workers. This is one of many reasons a wide variety of companies are attempting to digitize their operations with our technology. A large car rental company recently began deploying 5,000 ET56 rugged tablets at their airport locations to enable mobile associates to perform point-of-sale check-in for improved customer service. In healthcare, the need for real-time visibility into the entire patient journey, as well as the demand for technology that ensures safe and efficient care, continue to make healthcare our highest growth and market opportunity. The top-ranked U.S. hospital system recently selected Zebra's mobile scan and print solutions to integrate with their new electronic health record software application for patient bedside care which enables positive patient ID, specimen collection, and medication verification. Zebra's easy-to-use mobility solution and device management applications allows this customer to streamline clinician workflows, increase accuracy, and enhance safe patient care. Although the manufacturing sector has been hardest hit in 2020, sales rebounded to double-digit growth in Q1, We are focused on increasing automation in workflows for our customers and have been recognized as a thought leader in this market. We recently secured a takeaway win with a global food manufacturer who purchased more than 1,000 Zebra MC93 mobile computers and ET51 tablets. This customer has been equipping an increasing number of associates with technology to enhance their manufacturing, shipping, and receiving workflows. functionality, lifecycle management, and support were notable selection criteria cited by this customer. In closing, we are performing well in our primary end markets, and we are excited about the emerging prospects we see in newer markets to digitize and automate workflows. Now I'll hand the call back over to Mike.

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.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. And again, please limit yourself to one question and one follow-up. If you have additional questions, you may re-enter the question queue. At this time, we will pause momentarily to assemble our roster. And the first question today will come from Damian Karras with UBS. Please go ahead.

Hi, good morning, everyone. Congrats on the quarter.

Thank you. Thank you.

So you had mentioned that some of the first quarter sales strength was on pent-up demand from your smaller customer base. But just thinking about the current order strength you're seeing as you progress through the second quarter, would you still characterize some of that as pent-up demand? Or are we kind of past that at this point and it's really more reflective of your underlying run rate demand, if you will?

First, we're very pleased with our first quarter results here and the outlook we could provide. The business is supported by some strong secular trends that have accelerated during the pandemic, like Omnichannel. Most companies today are very focused on automating and digitizing their businesses. For us, that resulted in double-digit growth across all regions, across all products and solutions, as well as all verticals. So very broad-based demand for us. And we did see particularly strong growth from small and medium-sized customers. And that was partly driven by pent-up demand, but it's only partly driven by pent-up demand. But we also saw strong demand from our large customers, our larger strategic accounts. And I think another factor here was that based on our performance, I certainly expect that we continue to take share in the market. Nathan, do you want to add something?

Yeah, so just on the pent-up demand, I think, one, it is an estimate, so this isn't a precise deal reconciliation. And we think of it as recovering most of our 2020 myths to our original plan and guidance last year and recovering that here in the first half of the year, which is contributing low double digits both in the first and second quarter.

Okay, that makes sense. And then, you know, I think you spoke in the past that, you know, sort of later in the year is when you start seeing sort of the larger projects, if you will, larger orders. At this point, do you have some visibility there that you've kind of baked that into your guidance in the back half, or should we still expect that there, you know, could be some larger projects that haven't taken hold yet?

I think what we've said tends to be that our visibility into the larger deals or into our pipeline overall increases with time. So the closer, the further into the year we get, the better visibility we'll have to the second half and Q4. So part of what you see today is that we have gained some better visibility into both how we expect the run rate to progress, but also on some of the larger deals. But we don't have perfect visibility, so clearly there's opportunities for deals that we don't necessarily have scored as high likelihood in our pipeline today. Joe, do you want to add something to this?

Yeah, I would say that the large deal momentum has continued evenly throughout the year, and we have prospects for large deals in the second half, just as we did in the first half. One of the large deals that you're aware of is the USPS deal, which is, of course, contributing to our Q2 and Q3, as we've said.

Great. Very helpful, Collin. Thanks, guys. I'll pass it along.

And the next question will come from Tommy Moll with Stevens. Please go ahead.

Good morning, and thanks for taking my questions. Good morning. Good morning. Anders, it sounds like compared to a quarter ago when we talked both in terms of geography and market, it sounds like everything or nearly everything is better than expected a quarter ago. But if you had to pinpoint maybe one geography or one end market that's improved the most just as a driver for the raised revenue guidance, What would you point us to? And if I'm mistaken, and if there is any geography or in market that's gotten a little weaker over the last quarter, that would be good to know, although maybe just based on your tone and comments today, it sounds like there weren't any.

This is a hard question today because we have such broad-based demand. I don't think we've ever had a quarter where we've had each of our four regions, each of our verticals, and each of our main product categories all growing double digits. So it's hard to pick who stand out as particularly strong or weaker. But I'll probably just highlight maybe North America as particularly strong as being also our largest region here. We grew by 28%. So it's a very broad-based demand. across basically all our portfolio, the entire portfolio, but printing supplies, mobile computing, RFID, services, software, they were all up double digits. And we had strong wins across all our vertical markets in North America. And our newest vertical, the government vertical, also demonstrated good growth and growth I think it demonstrates the investments we've made in both product and the go-to-market for the government vertical paying off here now. From a vertical perspective, maybe healthcare is the one to highlight. It's been our fastest growing vertical for some time, and we expect it to continue to be the fastest growing one. It had a very nice performance in Q1. I think the transformation in healthcare is accelerating. It started off in acute care, but it's moving into other areas now, like ambulatory care, contact tracing, even remote patient care. And healthcare patients are now expecting or demanding a more digital experience. They prefer that also. And our purpose-built solutions are critical for healthcare providers to be able to improve the overall patient journey effectively. and to drive greater productivity for the healthcare providers across their operations. And, you know, some of our solutions in healthcare are also used specifically for COVID response, like drive-through testing and vaccinations, cold chain logistics, and so forth.

Maybe I can add something, too. If you look at the regions nominally, The one that swung the most from last quarter was Latin America. Latin America was the one that was hardest hit in the pandemic and has rebounded the most, but it's also our smallest region. In terms of verticals, another one that is notable is manufacturing, which was hit very hard in the pandemic as well, and we're seeing some good rebound in that area. I think the biggest swing that we haven't mentioned yet is one of deal size and customer size. So, notably, our run rate and the purchases by small and medium businesses have accelerated and are catching up now to what was a big driver in past quarters of the larger customers investing in e-commerce and digitization. We're now seeing that in the small and medium business, which, of course, manifests in our run rate.

Thank you both. That's very helpful. If I could ask one follow-up, Anders, I wonder if you could update us on some of the pilots you have with retail customers where all or at least a lot more of the store associates are carrying one of your devices. What's the progress there? How are you making the ROI case to the potential customers, and to what extent does Reflexus factor into the strategy there?

Yeah, the device for – for all is a big opportunity for us. We're very excited about how that's progressing. We see the theme around how most companies want to automate and digitize their operations as playing a big role in driving this. Across every vertical, I would say our customers are looking to put technology in the hands of more of their employees and be able to have them be connected and be able to both enter data as well as react to data. We see the relationship with Reflexus as very synergistic in that if you have a mobile device, you can now look at inventory stock outs or other information and upload that to the Reflexus task engine, which now can make smarter decisions, can prioritize the highest ROI action, and then mobilize that to the right worker at the right time through somebody who then is carrying a mobile device. So it's a very strong synergistic portfolio that adds basically the network effect. It adds to the value of both solutions by having both under one roof. The progression on deeper penetration is also progressing. I'd say it If you go back seven or eight years or something, a large super center in retail might have had seven or eight devices, and today they routinely would have maybe 70 or 80, but they may have several hundred employees, and we think that having a shared device for those associates when they're in the store is a big objective for, I would say, the vast majority of our customers, and that's progressing. We have some good examples of... where we've expanded our portfolio to provide the full range of devices across the price and performance curve, and where we've combined software and devices to really enable a much deeper penetration. And Joe, maybe you want to share some examples of this?

Yeah, I'll give you one example of a connection of our device for all and our SaaS software. One of the largest retailers in Australia is using our EC30 devices together with Workforce Connect to enable their associates to do tasks in the store but also communicate with one another. And that's one of the key use cases, which is, by the way, also enabled by Reflexus in the future, is to have the associates be able to interact with each other, which requires that all of the associates have a device. So I think that's a pretty good example of it.

Great. Thank you both. We'll keep our eyes out for more progress on all those fronts, but I'll turn it back for now. Thank you.

And our next question will be from Andrew Buscalia with Barenburg. Please go ahead.

Hey, guys. I was hoping you could talk a little bit more on gross margins in the quarter, which were obviously very strong. Can you break out what You mentioned software and then the reflexes or just acquisitions in general helping. Can you break out what that contributed in the quarter?

Yeah, this is Nathan. First, our teams have been executing very well on what we can control. You see that through the gross margin improvement year-on-year up 370 basis points. About two-thirds of that is related to business mix as well as volume leverage. We had an especially high mix of non-large orders due to the recovering small and medium business that Joe mentioned earlier. And about a third of that was from expansion of our service margins, as well as the Reflexus acquisition. And most of that coming from expansion within our service business. I think the one thing to also note, as we stated last year, if we look at our underlying gross margin trends, they remained healthy throughout 2020. And, you know, we expected the overall margin, and we're seeing that play out, you know, to improve as the mix has returned. Got it.

And, you know, EVM had, you know, particularly very strong gross margins, you know, 49%. Is that sort of the run rate we're looking at going forward? I know you have those freight expenses coming in, but, you know, is this sort of kind of the path you're taking? Do you think you can grow more? or expand margins even from that kind of elevated level, given some of this, you know, software and services integration.

I think, you know, over time, we do expect for, you know, our margins to improve. I'd say Q1 was especially favorable due to the strong mix of small and medium-sized business. But I think as that normalizes to more of a normalized level as we move forward, we do expect – EVM margins to improve over time, particularly, as you mentioned, with the growth and expansion of our software solutions.

Okay. And maybe this last one, because Q2, it's tough getting to that guide unless you assume a pretty big ramp in SG&A. So do we expect to step down in gross margins just in Q2 for some reason or given the freight expense?

Yes. So if you look at our Q2 EBITDA guide of 21% to 22%, it's It is up nearly three points year on year due to favorable business mix from 2020. Sequentially, it is down four points. Most of that is due to lower gross margin. As we said, you know, as deal size, I'd say, you know, kind of comes back from the exceptionally high level we had here in Q1. You also have CRS seasonality, a slight tariff recovery in the first quarter, all lowering gross margins sequentially, as well as we do expect higher OPEX. as we continue to accelerate investment in our new solutions, both in R&D and go-to-market.

Okay. Thank you.

And the next question will come from Jim Ricciuti with Needham & Company. Please go ahead.

Hi. Good morning. Just wondering what kind of headwinds you might be seeing or anticipating for the full year ahead Just as it relates to what we've all been hearing about component constraints, higher raw material prices, and just along those lines, do you anticipate potentially having to take any pricing actions going forward just given the supply chain issues?

Yeah, I would first characterize the supply chain issues that we're working on in two categories. One is logistical bottlenecks, and the other one is around the industry-wide semiconductor shortages that's been in the press quite a bit lately. First, on the logistical bottlenecks, that's really caused by a combination of increase in demand. We combine with a reduction in commercial air production traffic, so there are fewer commercial airplanes, which used to cover or carry a lot of commercial freight also. Then you add on a little bit of container shortages and port congestion on top of that, but this has resulted in air and ocean rates pretty much on all our key routes having increased by a factor of two since the start of the pandemic. So we are incurring premium freight costs as a result of this, and we are prioritizing meeting customer expected delivery dates. So we have been leveraging all modalities to get our devices and products to our customers, including chartering flights from China to Europe and the U.S. But this has had a negligible impact on revenues. And I'd say our supply chain team has done an outstanding job of being able to manage this and minimize the impact on the business. The other issues around the semiconductor shortages, and this impacts some of our products more than others. Our teams have been doing a great job of managing all angles of optimizing allocations for us. We have a history of thoughtful contingency planning, which I think is helping us here. We tend to qualify multiple components when we can and even have multiple suppliers when practical. We have seen, again, modest increases in surcharges related to sourcing these components. But despite both of these issues that are now mentioned, we're confident in the full-year sales outlook that we gave, that the outlook incorporates both of these points. And lastly then on the price action you asked about, we continuously assess pricing based on the competitive environment. So we always look at that, but we have no imminent plan of addressing or having a broader price increase to address these supply chain issues.

Thank you. And the follow-up, just on the AIT business, Andrews, I'm just wondering what you're seeing in the market in this legacy part of your business compares with previous recoveries and other economic cycles?

Yeah, we had an exceptional quarter for print. The growth rates were well above average, corporate average here. We saw growth across the portfolio and certainly pent-up demand had been an issue here. Smaller customers through the channel were recovering quite nicely. And we also, over the last year or so, taken some steps to strengthen our go-to-market around our channel ecosystem. And I think that's made us more competitive. We've been able to accelerate some share gains Our RFID printing business was also particularly strong, and even the supplies business was doing very well. Temp time was up double digits, so it was very strong performance across the board. Maybe I'll also highlight that Joe mentioned earlier that manufacturing was up very strongly in Q1 after having had a tougher go in 2020 and a little bit beyond that, also a little bit further that out. printing is the most exposed to manufacturing. So when manufacturing goes up, that would have a disproportionate impact on our printing business.

Thank you for that. Congrats on the quarter.

Thank you.

The next question will come from Metta Marshall with Morgan Stanley. Please go ahead.

Great. Thanks. A quick question. As some of these smaller customers come back, You know, what are they asking you for that may be different from, you know, what they were asking you from before? Clearly, they still kind of face some challenges in the competitive environment. Just wondering what they're asking you for in particular. And then maybe on the healthcare opportunities, just as you move past some of these kind of COVID-boosted use cases, where are you seeing the most traction in use cases there? Thanks.

Yep. I will start, and then I will ask Joe to also provide some color here. So first on smaller customers and what we're seeing, what's different. I'd say two things. One is, you know, irrespective of size, I would say pretty much all customers across all verticals are looking to figure out how can they digitize and automate their businesses more. And they do look to our type of solutions to to connect the physical world to the digital world, to really help them connect that physical workflow, those workflows, into applications and automate them better. So that is a broad-based theme across basically all sizes of customers and verticals. The other point that would be our larger customers were generally able to pivot to a operating world better. They were generally seen to be essential businesses or deemed to be essential businesses, while many of our smaller customers, many of them were in manufacturing, had to shut down. And now as they come back, I think they're looking to make investments that enables them to compete with some of their larger brethren who have invested earlier in those digitalization and automation themes. Joe, do you want to add anything to this?

I think you said it well on the small and medium businesses. Clearly, the pent-up demand portion was still most pronounced among the SMBs, I would say, and they're catching up more on their pent-up demand. But beyond that, it is really those small and medium businesses going to the next level of digital transformation, just as their larger brethren have. You also asked about health care, and on the health care beyond COVID-19 use cases, we're seeing an expansion, as Andres had mentioned, in the prepared remarks into new areas of health care, like ambulatory care, like remote patient care. So the use of tablets, for example, in order to enable remote patient care is a big use case. Communication, of course, is a big use case. And one that we're also seeing a lot of interest in is asset and people tracking in hospitals, locating the right person or locating the right asset for a particular procedure. Those are new use cases and are driving some of that accelerating demand we mentioned.

Great. Thanks.

And the next question will come from Keith. Howsome with North Coast Research. Please go ahead.

Good morning, guys, and congratulations on a great quarter and solid guidance. I just want to unpack the gross margin growth again just a little bit more. The software and services obviously had a great step up compared to, you know, in the fourth quarter or the first quarter of last year. And I understand last year's step up was due to the European services improvement. It sounds like a further improvement this time around. This 47% roughly gross margins, is that sustainable going forward? Is this like a new normal for you?

Yeah, Keith. So just first part of your question. So the growth in both our service and software, again, seeing on both ends, right? The addition of Reflexus and the gross margin being higher than the company average is helping, but also from an organic basis up nearly seven points year on year from our core service business. And You know, part of that is due to the actions we took over the last several years to improve efficiency and streamline the repair operations, and the team's continuing to work that. And then the other is now that, you know, with double-digit revenue growth, seeing that volume leverage flow through the P&L is the other big driver of the margin improvement. And we do expect that to, you know, continue to grow year on year as we grow the top line as well as improve efficiency in the operations.

Great. Great to hear it. And then in terms of your overall growth, you know, I understand there's multiple drivers of your revenue growth, but can you touch on perhaps the growth that's been contributed from the new products and perhaps expansion into new markets that perhaps we're not doing as well in before, just trying to dimensionalize some of the growth aspects there?

Yeah, so when you say new products, you mean new types of solutions or just new products more generally?

Give me more types of new solutions, looking for new customers, new use cases that perhaps your prior generation of products did not previously address.

Okay. I'll start, and Joe, you can provide some more insights here also. I'd say we did see RFID having a very strong quarter in Q1. RFID had a tough going last year, but that's really started in Q2, so Q1 last year was more of, you know, was pretty reasonable quarter, so this is a strong rebound for RFID, and we see these types of solutions which are more contactless as having a great, being in demand, and see more deployment of them. I would say also our software solutions are having great traction. The combination of Reflexis, CBA Prescriptive Analytics, and Workforce Connect provides a very differentiated value proposition for us, Each of those offerings in and of themselves are performing very well, but when you then combine it as a suite and then look at how they interact with our mobile devices, that provides a very compelling offering, which we see having great opportunities for us to continue to grow. And some of our other intelligent edge solutions are still probably... Little slow in ramping as we've had, still have a hard, you know, we don't have access to our customers' facilities to the extent we used to, to do, you know, pilots and proof of concepts and other types of engagements like that. But we expect that to ease up here as we get through COVID and get back into more normal way of operating with our customers. Joe?

Yeah, I'll add, maybe add a couple of things that could be helpful. In terms of the mobile computing segment, we talked about the device for all. And as Anderson previously described, we're seeing an expansion of this. This isn't necessarily always a big bang where someone just rolls out devices to everyone, but an expansion to additional sets of people, right? Now you use it for transport in a hospital, not just for nurses, for example. So that's been a big expansion. But we've also had some very innovative use cases. One of them we recently published in a press release for a tire chain that is now using our devices to not only keep track of the tires and the inventory, but also measure the tread depth and offer a new service to a customer. That type of innovation, I think, is going to be providing new use cases as well. And I'm also quite proud of... our ability to grow the tablet segment that we accelerated through the acquisition of Explore some time ago and to combine with our own ET tablets. And we have some very good traction there. From a vertical perspective, two that I would call out is the government and the healthcare segments. The healthcare segments have seen a good acceleration internationally. You know that we've always had a, reasonably strong position in North America, but now we're seeing deals in Japan, in Australia, in, in, um, uh, in the UK, uh, that are sizable, right? Where these, uh, institutions are modernizing their infrastructure globally and government is, we've mentioned this an area, not just in the U S but also in other countries, again, around the world that we've made substantial go to markets investments. And we're now seeing accelerated growth, um, most of the mobile computing, but also some printing opportunities with governments around the world.

Great. Thank you very much.

The next question is from Richard Eastman with Bayer. Please go ahead.

Yes, good morning. Just very quickly on the gross margins, did the China tariff benefit, did that all fall into the EVM gross margin?

It would have fallen between both EVM and printing. So we had both, I don't have the exact split off the top of my head, but it was equally or proportionally weighted between EVM and AIT. Okay. And then just, is there any visibility on that?

I mean, going forward, you know, Q2 through Q4, is that benefit continue?

We do expect the benefit to continue. We have not included that into our guidance for the quarter or the year in terms of incremental benefit as, quite frankly, it's very hard to predict when and how the claims we've processed will be approved and paid. But it's something we continually work and actively manage. But, yeah, it's pretty tough to predict the timing of when we expect to get the recovery from the government.

I see. Okay. And then just maybe as a second question, around the core growth in the quarter was 25%, I believe. Could you just speak to what the growth relative in the channel was versus direct? And does the U.S. Postal Service fall in the direct piece that you're going to hopefully define for me?

I think Joe can probably provide most color of this, but USPS will be a channel customer. I think, Joe. And second, our channel business had a fantastic quarter with, I believe, stronger growth than what we had in our direct accounts. Joe?

Yes, I can confirm that. So our strategy has and remains to be channel-centric with the vast majority of our revenue going through the channel. And I'm happy to report that our channel has once again grown faster than our business overall. and has therefore expanded the portion of revenue that goes to the channel.

And just lastly, and related to this, I've got a question on just the press release that came out a little bit ago here, kind of mid-April. But you talk about this Partner Connect Alliance track thing. And it's complementary to the independent software vendor track. But just talk about maybe this expansion of, you know, of non-selling VAR partnerships. And just what that brings to the table here. And is that, you know, there's an investment made in these channels. But just maybe speak to that, how that expands the opportunity set for Zebra. Do you want me to take that on? Yes, please.

Yeah, so of course, VARs have been the core of our Partner Connect program. We've added ISVs, especially in the Android transition, because of the importance that the software that runs on our devices has and how the customer comprehends that as an integrated solution and wants to buy it that way. So we recognize ISVs as influencers of the customers, aligned ourselves closely with those, and are proud to have some of the largest ISVs available. in our program. But we've also recognized that there are other important influencers. I'll give you an example to make this real, which is if you think about network equipment providers, people that provide Wi-Fi infrastructure, for example, for a customer. Almost similar to the ISVs, they are looking to provide solutions to customers, like, for example, locationing capabilities, right, within the environments that they outfit. And by working with us, they can enable such solutions. And we recognize that and created this alliance track in order to allow us to work more effectively with those kinds of partners. And it's paying off very nicely for us.

So it's basically lead generation. I mean, is that where you look to at these other influencers around ID products?

It is lead generation.

Sorry, go ahead. No, that was my question. Yeah.

It is lead generation, but it is perhaps even more effective in allowing us to close the opportunities, right? When a customer sees that we're aligned and that we're working together, we have a greater chance of winning. Okay.

Okay, very good. Thank you.

The next question will be from Brian Drab with William Blair. Please go ahead.

Hi, thanks for taking my questions. First on the EBITDA margins, I guess the full year guidance implies that first of all, you gave us the 21.5 midpoint for the second quarter, but then the full year guidance implies the same 21.5 level for the third quarter and fourth quarter. I'm wondering if that's fair to assume that that will be the run rate for the balance of the year and no big swings between third and fourth quarter. And also is the premium freight headwind something that will persist or is that, can that fall off maybe later in the year? And just wondering how much conservatism might be baked into that 21 and a half after putting up 25 and a half almost in the first quarter.

Yeah. So if you look at our full year guide of 22 to 23%, you know, We do expect gross margin in that to improve year on year, particularly as our software solutions grow. And we do expect premium freight costs of $50 to $60 million, which we've raised by $20 million, most of that coming in the second half. We really don't see any change in those expectations from what we're seeing here in the first half, or at least it's hard to predict when particularly the supply side will come back around commercial air travel. That's also $20 million higher than all of our 2020 transitory costs, including tariff. And we also expect to continue to invest and grow OPEX as we accelerate investment in some of the high ROI opportunities, including the continued integration of our software offerings with Reflexus.

Okay, thanks. And then can you – provide some details on the competitive environment as you're seeing it. Anything you can share in terms of what your share of the mobile computer market is now from your perspective and what your share of the barcoding equipment market is. So much has changed in the last year with the industry just exploding. And then also within mobile computing, can you talk about what percent was Android versus Windows based? in the quarter, thanks.

All right, I'll start and we'll see here if I missed anything. So competitive environment, first let's say we're very confident in our competitive positioning. I'd say as confident as we've ever been probably. We're coming out of COVID-19 with good momentum and we've actually gained share as we've gone through last 2020 here. We took the tack of continuing to invest in new solutions and staying as close as we could with customers. We actually launched more new products last year than we've done in any other year in the history, and I think that's coming back to benefit us here now. Our markets are, we think, very attractive. We have some strong secular growth trends. I mentioned the trends around digitizing and automating workflows as a broad theme. I think that's something that's very broad-based and we believe will be something that companies will invest in for several years. We have some strong advantages also. We have our scale, our goal-to-market network, the ecosystem we have there. So there's a number of things that will make us formidable competitors from that perspective. And lastly, I'd say our vision, our enterprise asset intelligence, something that differentiates us from our competitors. When our customers talk to us, they're not looking to just buy the device for the here and now. They're looking to see how they can partner with somebody who can help them drive that digitization and automation of their operations into the future. From a share perspective, we get share data from independent sources, and they tend to lag, so we only have Q4 data. but we had a record share in mobile computing, I think it was over 50%. On print, the number two, I think, is 12%, certainly directionally in that area. On print, we have a low 40%, 43%, I think it is. And our second competitor is low double digits, I think also about 12%. And in scan, we have about 30% where our competitors Second largest is more like 24%. So we have strong position across our business. And your last question was about the mix of Android and Windows. And we now have over 85% of our mobile computing sales are Android.

Thank you. Please proceed, Mr. Hill, if you needed to entertain the question further.

Our share in Android remains particularly strong. We probably have approximately 60% of the share of Android. So we're particularly strong in that Android element. Yeah, that's a good answer.

And the final question will come from Blake Gendron with Wolf Research. Please proceed.

Hey, good morning. Thanks for squeezing me on here. I wanted to start with cash flow. So relative to the wording of at least $700 million in the prior guidance, the current guide is appreciably higher. So I'm wondering how we can think about free cash conversion in the context of both, number one, growing software mix, and number two, the healthy channel growth that you mentioned. I would imagine that hardware-led pent-up demand recapture would see some working capital drag in 2021. But as we look into 2022 and beyond, is there a way we can think about free cash conversion that's perhaps structurally different from what it's been in the past?

So the first part of your question, just in terms of the full year guide of greater than $850 million, really just aligns to the increased profitable growth outlook for the year. So no notable changes from a working capital perspective relative to our last guide. Our target year in and year out is to be at 100% free cash flow conversion. This year will be slightly lower than that just because of the strength we had in 2020. But we don't see that noticeably changing as something we can achieve over time as we move forward.

Okay, that's helpful. And then one quick follow-up here. Interesting win with the tire customer. And that application seems like it follows a machine vision approach. There's a large machine vision competitor that is a small handheld scanner device business somewhere in Zebra's purview. There's a little bit of overlap. Do you think that this overlap increases, you know, particularly in the manufacturing realm? Is there any M&A to do here? You know, a lot of what we're hearing in terms of automation, AI deployment within, you know, the manufacturing facility is coming from the machine vision customers, which seems like it's on the periphery of what Zebra does. But that would be helpful, you know, perspective.

Yeah, machine vision is a very exciting sensing and data acquisition technology for us that helps us enable intelligent automation solutions. We've already incorporated machine vision into a number of our solutions like SmartPak, SmartSight, our MP7000 flatbed scanners with a colored camera. So we clearly see great opportunities to continue to leverage machine machine vision to create unique solutions for our customers. The tire tread depth sensor, that is an accessory that we put on our mobile computers to be able to do, but it's another example of how we're trying to find use cases where we feel that we have a strong right to play and where we can be competitive. And I expect that machine vision is going to be continued area for us to invest. We acquired a company called Cortexica about 18 months back, I think it is now. That was basically an engineering team that had deep expertise into machine vision. Their focus was on figuring out how to extract useful information from digital images and video. And they've been a great addition to our team in helping our other solutions accelerate the deployment of our other solutions.

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to Mr. Gustafson for any closing remarks.

Yes, so to wrap up, I would like to thank our employees and partners for their focus, dedication, and resiliency, leading to exceptional Q1 results and an improved outlook for 2021. Our top priority continues to be protecting the health and well-being of our employees, partners, and customers as we recover from the pandemic. Stay safe, everyone.

Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.