Zebra Technologies Corporation

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, 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 of Investor Relations. Please go ahead.

Good morning and welcome to Zebra's third 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. Our forward-looking statements 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 third quarter results, then Nathan will provide additional detail on the financials and discuss our fourth quarter 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 turn to slide four as I hand it over to Anders.

Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered exceptional third quarter results that exceeded our outlook, supported by robust broad-based demand for our solutions. For the quarter, we realized adjusted net sales growth of 27 percent, or 23 percent on an organic basis, an adjusted EBITDA margin of 21.7 percent, a 140 basis point year-over-year improvement, Non-GAAP diluted earnings per share of $4.55, a 39% increase from the prior year, and strong free cash flow. Our customers are prioritizing investment in our solutions to digitize and automate their workflows in an increasingly on-demand global economy. We realized double-digit sales growth across all four regions with particularly strong growth in EMEA. Favorable business mix and higher service and software margins enabled us to expand our gross profit margin despite escalating freight costs. Our teams have been diligently leveraging alternative modalities of transport and expediting shipments to mitigate the impact of continued industry-wide supply chain challenges. We also scaled operating expenses while continuing to invest in initiatives to drive sustainable, profitable growth. With that, I will now turn the call over to Nathan to review our Q3 financial results in more detail and discuss our Q4 outlook.

Thank you, Anders. Let's start with the P&L on slide six. In Q3, adjusted net sales increased 26.6%, including the impact of currency and acquisitions, and 23.2% on an organic basis, reflecting broad-based demand for our solutions from customers of all sizes. Our asset intelligence and tracking segment, including printing and supplies, grew 12.1 percent, while enterprise visibility and mobility segment sales increased 27.9 percent, driven by exceptional growth in mobile computing. Note that we also realized double-digit growth across services and software. All four regions grew double digits. North America sales increased 14 percent with particular strength in mobile computing, supplies, and services. EMEA sales increased 39 percent, with strong growth across all major solutions offerings, particularly mobile computing. APAC sales grew 17 percent, with strength across most geographies, including China. And in Latin America, sales increased 41 percent, continuing its strong recovery with double-digit growth in all major offerings. Adjusted gross margin expanded 130 basis points to 45.1%, primarily driven by favorable business mix and higher service and software margins. These benefits were partially offset by significant premium freight charges, which we will discuss further in a moment. Adjusted operating expenses as a percentage of sales improved 30 basis points as we continue to prioritize high return investments in the business. Third quarter adjusted EBITDA margin was 21.7%, a 140 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 $4.55, a $1.28 or 39% year-over-year increase, which benefited from lower interest expense and a favorable tax rate. Turning now to the balance sheet and cash flow highlights on slide seven. We generated $798 million of free cash flow through the first nine months of 2021. This was $316 million higher than the prior year, primarily due to increased profitable growth. Our balance sheet remains strong. From a debt leverage perspective, we ended Q3 at a modest 0.5 times net debt to adjusted EBITDA leverage ratio which provides us ample flexibility. In the first nine months of 2021, we invested more than $300 million to acquire Fetch Robotics and Adaptive Vision to advance our intelligent automation solutions in manufacturing and the warehouse. We made $24 million of venture investments in four portfolio companies. In addition, we made $38 million of capital expenditures and $25 million of share repurchases. On slide eight, we show the multi-year impact of transitory costs primarily related to expedited freight due to supply chain bottlenecks caused by the pandemic, as well as tariffs on China imports. Our supply chain team continues to take extraordinary measures to satisfy customer demand in an exceptionally challenging environment. Global freight costs are elevated for all modalities of delivery across our supply chain. This includes higher shipping costs per kilo, a significant shift from ocean to air freight, as well as increased costs to expedite component parts to our Tier 1 manufacturers to meet customer commitments. In Q3, compared to pre-pandemic rates, we incurred incremental premium freight costs of $44 million, which were $36 million higher than the prior year. For Q4, we now expect approximately $55 million of premium freight costs based on the higher spot rates we are seeing in the market, which translates to a four percentage point negative gross margin impact. We expect premium freight costs to abate as component supply and freight capacity improves. Let's now turn to our outlook. Our robust sales pipeline and strong order backlog is supported by broad-based demand for our solutions as enterprises look to automate their operations to satisfy increasing consumer expectations. Despite extended lead times and uneven inventory availability, we expect fourth quarter adjusted net sales to increase between 8 and 12 percent year-over-year. This outlook assumes a two percentage point additive impact from acquisitions and foreign currency changes. We anticipate Q4 adjusted EBITDA margin to be slightly higher than 21 percent, which assumes gross margin contraction from the prior year due to significantly higher premium freight expense. which I discussed earlier. We are also experiencing product component inflation, which we expect to largely offset with price increases that became effective in September. Non-GAAP diluted EPS is expected to be in the range of $4.20 to $4.50. We have increased our free cash flow outlook to be at least $950 million for the year due to higher than expected profitability. Please reference additional modeling assumptions shown on slide nine. With that, I will turn the call back to Anders to discuss how we're advancing our enterprise asset intelligence vision in new and existing markets, with spotlights on our acquisition of Intuit and our healthcare vertical.

Thank you, Nathan. I am encouraged by the strengthening demand across our business and the bold actions our teams are taking to navigate supply chain challenges. Slide 11 illustrates how we digitize and automate the frontline of business by leveraging our industry-leading portfolio of products, solutions, software, and services. By transforming workflows, Zebra's customers can address complex operational challenges to achieve higher levels of performance. By closely collaborating with our partners and customers, we help businesses across a variety of end markets to implement solutions that maximize their return on investment. Human labor is a scarce resource. Our innovative solutions empower the workforce to do their jobs more effectively by navigating constant change in near real time, utilizing insights driven by advanced software capabilities such as machine vision, prescriptive analytics, and artificial intelligence. In October, we acquired Antwit for approximately $145 million to further advance our enterprise asset intelligence vision. This high margin software as a service business generated sales of approximately $27 million in 2020, nearly doubling over a three-year period. Slide 12 illustrates how the AI-powered demand forecasting solution ensures that its retail and consumer product customers have the right inventory at the right time at the optimal price, whether it's fulfilled through online ordering or in-store shopping. Antwit's cutting-edge offering complements our suite of workflow software solutions, including Reflexis, Zebra Prescriptive Analytics, Workforce Connect, and SmartCount, which work together to increase the performance of labor and inventory across the integrated supply chain. A growing software suite will help our customers break down silos between planning and execution, giving them a competitive advantage that can increase revenue and margins as they navigate the increased demands of omnichannel fulfillment. Now turning to slide 13. Businesses partner with Zebra to optimize their end-to-end workflows. I would like to highlight a few recent key wins across our end markets that demonstrate how Zebra solutions are improving productivity and service levels. In retail, Zebra is enabling improved execution of omnichannel fulfillment as more consumers shop online. We recently secured our largest win to date in India, providing TC21 mobile computers and printers to help a local retailer compete more effectively against its larger omnichannel and e-commerce global competitors. We are also enabling a Japanese supermarket chain to provide an improved customer experience with our EC55 personal shopping mobile computing solution. Over the next several quarters, a leading home improvement retailer will be deploying 90,000 TC52 mobile computers to a broader number of associates in their stores. Key use cases include item locationing, best-in-class long-range imaging, mobile point of sale, and e-commerce functionality. Competitive differentiators for this win included our seamless network connectivity, best-in-class noise cancellation, and enterprise-leading durability. Our mobile computers will also have full desktop functionality when inserted into workstation cradles. This retailer is also deploying our Workforce Connect software-as-a-service solution which enables associate-to-associate instant collaboration, as well as associate-to-group and store-to-store communication. The leading North American transportation and logistics company is deploying 9,000 TC77 mobile computers to their truck drivers for loading and delivery use cases. The solution will increase productivity, improve inventory accuracy, log driving times, and track regulatory compliance. Turning to slide 14, we highlight how healthcare providers are using Zebra solutions to digitize and automate the patient journey and address labor challenges. Our recently published vision study highlights that 95% of decision makers expect to increase spending in healthcare IT and clinical mobility in the next year. We have some exciting recent strategic wins that demonstrate our value proposition. We recently secured a takeaway win of a leading U.S. healthcare provider with more than 150 hospitals and approximately 2,000 sites of care. This customer selected Zebra to provide a multiyear rollout of 85,000 scanners for a wide range of use cases, including bedside nursing, surgery, pharmacy, and inventory management. They also recognized are unique software tools that enable real-time event tracking to prioritize patient care. A large Eastern European public hospital system recently placed an order to provide 19,000 TC25 mobile computers to nurses across 100 hospitals. Hospitals are facing labor shortages made worse by the pandemic, which puts patient safety at risk. Zebra's solutions, including printers and wristbands, reduces the administrative burden on the nursing staff and allows for more efficient patient care. Our value proposition to this customer also includes real-time tracking of costs of supplies, equipment, and medicine. Additionally, Zebra is growing our longstanding relationship with GE Healthcare, whose solution, Encompass, utilizes Zebra's Bluetooth beacon technology for medical equipment asset management. This solution improves asset utilization and prevents unnecessary equipment replacement purchases. Caregivers also benefit by reduced time searching for medical equipment, which can increase time dedicated to patient care. In closing, the pandemic has accelerated trends that have been driving Zebra's business, including omnichannel shopping adoption, the desire for track and trace across the supply chain, and the need for a more digital healthcare experience. Our core markets are vibrant, and our prospects to scale newer expansion markets are bright. We are steadily navigating through significant transitory industry-wide supply chain challenges. That said, we continue to be as excited as ever about our long-term profitable growth prospects. 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.

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. At this time, we will pause momentarily to assemble our roster. The first question today comes from Tommy Moll with Stevens. Please go ahead.

Good morning, and thanks for taking my questions.

Good morning.

Anders, I wanted to start on your Intuit acquisition. I wondered if you could highlight a couple ways in which it might be synergistic with your portfolio, and I really had two buckets in mind. First, just in terms of scale, you've got more robust go-to-market capabilities, more robust R&D dollars you can put against it. So what would you highlight for us there? But also just in terms of the portfolio and fit. So if I'm a customer, what augmented capabilities will you be able to deliver with the software platform, given you've got other software adjacencies and and hardware opportunities to deliver a solution versus what the portfolio, or rather what Intuit would have done as a pure standalone business?

Yeah, I'll try to go through and give you some insights to each of those points. But the first, you know, this helps us in our, to augment our solutions around, improving retail store execution for our customers, as well as for consumer products companies. It is very synergistic with our enterprise asset intelligence vision. And, you know, we talked about our Sense Analyze Act framework here, and this is very much around the analyze and act part of this, enabling our customers to sense what's happening in the real world, analyze this information, and act on it in real time. The solution that Antwit offers is a demand sensing solution, it's called. They take in lots of different data feeds, anything from, you know, in-store sales to weather, social media, and, you know, use that to determine basically what demand trends will be. And they can be very quick and do this much better say, traditional models. If you take an example like when COVID happened, Antwit's algorithms were able to better and quicker adjust to this new environment. And it's very, say, synergistic with our other offerings, particularly, say, on the software side, where, say, take Reflexis, where Antwit's insights will be will generate actions for our reflexes task management solution. So they can be to go and replenish something, move inventory from the back of store to the front of store or other parts of the supply chain. So it is very much kind of works synergistically with our broader software solution, as well as with our devices. So our mobile computers will generate insights that Antwit can analyze and put into its AI algorithms to derive better insights from. And with this broader set of solutions, we position Zebra to be more of a strategic solutions partner to our customers. And we have access to more executives or more customers and more executive level people at their customers than Antwit would have individually. So therefore, we think that this fits very well with our broader strategy.

Thank you. One other addition. This is Joe Hill. If you think about the customer set, you mentioned go-to-market that Antwit targets. It is primarily merchandising executives in retail and in packaged goods. Of course, retail is a very strong segment for us, so that should give us the ability to leverage our scale to the benefit of Antwit's offering. And conversely, we have a position in packaged goods, but Antwit will give us a stronger offering to further expand our offerings in general, not just Antwit, but in the way Andrew's described, into packaged goods.

Thank you both. That's very helpful. I wanted to pivot from my follow-up to the margin. And again, we appreciate the transparency you've offered around the premium freight headwinds and the trajectory there. So we're looking at $55 million for Q4. And my question really is the following. If you think about how the fourth quarter is progressing, both in terms of the realization of some of the pricing actions you've taken, then also you've got on the cost side, it's dynamic and presumably changing on a day-to-day or week-to-week basis. if you think about where you likely end the quarter once all that rolls through versus the full quarter outlook you gave, I think it was above 21% for the quarter. Does it feel like the exit rate is probably a little better than that average, or how do you see things shaping up here in real time?

Tommy, maybe just to start with the fourth quarter, as you mentioned, you're slightly above 21%. That is down from prior year, a little over two points. So, four points, that's the premium freight, but offset by favorable business mix, as well as improved service margin, as well as improvement just in the underlying product margin. And as you mentioned, we have raised prices to offset the component pricing, so the unit price. I think So that's something we're continuing to monitor and assess is how the transitory impacts play out. I would say from a logistics and freight perspective, we do expect that to moderate through the first half of 2022. But I'd say it's, you know, something we're managing, you know, day to day, week to week. And we'll see how the quarters play out in terms of when we start to see a meaningful benefit from where we're at today.

And Nathan, just to make sure I'm tracking you here, it sounds like the pricing actions are really more targeting the product aspect of inflation rather than the freight. Am I hearing you correctly? That's correct. Okay.

That's correct. We have not raised prices to offset the transitory premium freight expenses, but that's something we'll continue to assess as this plays out.

Great. Appreciate the insight, and I'll turn it back.

Our next question comes from Andrew Biscaglia with Barenburg. Please go ahead.

Hey, guys. Just on that question around margins, how were you able to manage sort of the supply constraint issue in securing parts for your products? And it seems broadly across most of industrial customers and companies in general, these constraints will continue into next year. So I guess what are you doing on that side of things to manage you know, you talked about the freight cost, but just wondering in terms of securitization of parts.

Yeah, so I'll start kind of at a higher level here. You know, if you look at the broader backdrop, you know, demand has ramped very fast over the past year, and we have now prioritized meeting our customer needs and commitments. And while we are not always able to meet our traditional lead times due to these industry-wide supply chain challenges. We have been working with our partners and customers to make sure that we can deliver very strong double-digit year-over-year growth. And I'd say based on feedback from our customers and partners, we've been managing this better than our competition. you know, specifically for how to secure parts. You know, we're looking at the semiconductor industry shortages. You know, that has impacted the availability and pricing of some parts more than others, or some of our devices then more than others. This is a, you know, highly dynamic environment, and we get, say, we sort out and get good news on some parts. The next day, we get, you know, some more challenging news on other parts. So, it is kind of very much of a dynamic environment for us. But I'd say our teams have been working very well, done an exceptional job of working all angles to figure out how to mitigate these issues. Starting with, we've been built more resiliency in our supply chain by putting in new assembly plants across Southeast Asia, so we're less dependent on any particular plant. And in Q3, for instance, we had to move volume between plants based on COVID outbreaks. So that was a great way for us to leverage that. We also worked really hard to engage with our semiconductor suppliers to make sure that we get our fair share, so we get our proper allocations of parts. And we're having a large part of our engineering team working on redesigning our devices to qualify new alternative components that are not as exposed to or limited with supply. So, you know, we're doing all of these things to ensure that we can meet our customer needs as well as possible here. But as I said, it's a dynamic environment. It's difficult to predict how exactly it's going to play out. But based on our conversations with our suppliers, I'd say we expect a gradual improvement by mid-2022 on the component side.

Okay. Yeah, that's helpful. You do stand out as someone who's managed you know, these constraints very well and you're raising a line of fire of that issue. So I thought, you know, it does sound like you have the capabilities in place to keep that going. I think, you know, on the demand side, I thought that your AIT sales would be a little bit higher. How much of that is related to the supply constraint issue or are you seeing any sort of moderating in demand?

First, I'll say we continue to drive innovation across the entire portfolio of product and solutions, and we're helping our customers to digitize and automate their operations. And the core business is very vibrant, and we're very excited about the adjacent expansion opportunities that we have. Now, specifically for printing, you know, we had a very solid, we delivered a very solid growth across the regions in printing. Printing was up across most of its portfolio. We had particular strength in manufacturing, which tends to deploy mostly tabletop printers. We also saw a strong run rate or smaller business through our channel. But it's fair to say that printing was disproportionately impacted by supply chain challenges. And that includes both component issues, but also that our main assembly plant in Southeast Asia had to, you know, almost shut down based on COVID. And we had to shift a lot of the volume from Vietnam to China. So that took some capacity out of the quarter. But it was, you know, still was a very good quarter for printing. We could have done probably a little bit better. But, you know, we still believe that we continue to gain share. Certainly, year to date, we gained a lot of share in printing. And also in the AIT segment here, we had very strong growth in supplies across all regions, and that includes our temp time portfolio. And, you know, in Q2, we launched our new SOHO printer. Very excited about that. That's off to a good start.

Thanks, Anders.

Our next question comes from Jim with Needham & Co. Please go ahead.

Hi, good morning. I'm wondering if you could, how you would characterize your large projects business. Andrew, you highlighted a few nice wins, and I'm also wondering to what extent that business is being impacted by the component constraints, the logistics challenges, whether customers are themselves being impacted by bottlenecks elsewhere in their supply chain that's affecting the timelines for when these projects are going to go forward?

I'll start with our large customers, our larger projects continue to do well. We saw growth in that year over year. But the mix between our run rate business and large customers has moderated, gone back to a little bit more what we would see as historically normal rates versus what we saw a year ago. I don't think we can say we've seen any impact on our customers' rollout schedules based on supply chain issues. And we clearly work really hard with our large customers as well as our channel partners to make sure that we understand what is... So true demand, what our customers truly need to have in order to run their business versus what they might want to have or think of as more risk buys. So we can satisfy all our customers, but particularly our larger customers here. you know, demand from them continues to be strong and as in line with what we've seen previously. And maybe, Joe Heal, do you have any additional color here?

Yeah, I would echo what you said. We have not seen any delay in large businesses due to bottlenecks on our customers' parts elsewhere. And we have had some extraordinary wins even in this past quarter. As you know, the large projects are somewhat lumpy here and there, but we had double-digit growth nearly in the large projects business as well, including some extremely nice wins in multiple geographies. So we're very pleased with it.

Got it. And follow-up, just appreciate the color on your expectations looking out to the first half of next year as it relates to components. and some of the unusual freight costs you're incurring. I'm wondering how we should be thinking about your operating expense levels over the next several quarters, only because things are beginning to normalize. We have presumably trade shows starting to occur again, and I'm just wondering if we need to be mindful of some temporary cost savings you might have benefited from this year being layered back in over the next several quarters?

Yeah, Jim, I think it's fair to say that as we go into next year, we do expect some of the discretionary spend, particularly around travel and trade shows, to pick up. But I'd say it's, you know, no different than any other variable we manage within the year in the pluses and minuses and still expect to grow despite, you know, some of those incremental costs that we'll incur. And as usual, we'll find offsets and efficiencies to mitigate that impact as we go into next year.

Got it. Thank you. I'll jump back in the queue.

Our next question comes from Netta Marshall with Morgan Stanley. Please go ahead.

Great. Thanks. I wanted to maybe first ask a question just on kind of seasonality. You know, I know a lot of your retail customers don't tend to be as active in Q4, but we're also kind of dealing with a labor shortage. So just any kind of perceptions of what you're seeing as far as seasonality into Q4. And then maybe a second question, you know, clearly you're highlighting success within healthcare. And, you know, this has been a continued area of success for you guys. Are you able to use kind of your traditional go-to-market, or are there partnerships that you think you could explore that would kind of further accelerate that opportunity?

Thanks. Thank you, Meera. I'll start, and then I'll ask Joe Heald to provide some extra color here also, but first on seasonality. I think seasonality this year has been similar to what people would normally have seen, but a you know, with slight increases quarter over quarter in Q3 and into Q4. So, not a huge difference from that perspective. Obviously, you know, demand has been strong and very broad-based. So, that certainly helps on the overall, you know, demand profile, but I don't think The seasonality has meaningfully changed, and Joe can comment on that in a second. On the other part, on healthcare, yeah, healthcare has been our, you know, fastest growing vertical, if you look over the last several years, and we would expect it to continue to be our fastest growing vertical, not necessarily every quarter, but over a longer period of time. And we have built up a, we said, first, we're leveraging our traditional sales team, but we have a dedicated healthcare sales team within our sales organization. And we have largely dedicated healthcare partners. You know, if you take somebody who's an expert in manufacturing and send them to hospital, that's, you know, the language is different. The solutions are different. So it really warrants to have more specialized partners. And we have a large number of specialized, both regular resellers, but also ISVs and other partners to help us make sure that we have as robust a go-to-market organization and capability as we can. Joe? Did we lose Joe? All right.

I'm sorry. This is Joe Gil. I would add to each of those points, respectively, the following. On the seasonality, the one additional thing we have seen is that retailers have been ordering further in advance, right? They're seeing, of course, the shortages that exist in the supply chain and are working with us to anticipate those. So that means that we can plan our supply to them further in advance. And so our reflection of their seasonality is sort of pulled forward in that regard. In terms of healthcare and the go-to-market that we use there, as Andrew said, yes, we have specialized partners in those areas that we have been building out over the last few years. Two other things I think characterize our go-to-market and routes to market in particular. One is we have a higher than average investment of our own resources. We have learned and determined that being present in those hospitals, which is, of course, a more fragmented customer set is important. And therefore, we have made more investments in our own resources in those areas, and we're more present together with our partners, of course. And then the second is that we've also learned that we need to expand our partner set to more, let's say, nontraditional partners, which would include, in particular, ISVs. They're very important. ISVs for electronic health records that we need to form partnerships with, and OEMs. There are important OEMs that participate in the healthcare segment, and we have formed some very strong alliances with those as well, and that's helped us with our growth in healthcare.

There's one more point to this. We have, as we work with our customers now, particularly Joe mentioned retailers, we have a greater visibility. The supply chain constraints have enabled us to get greater visibility into their requirements. And our pipeline is more robust. And we enter quarters with a greater backlog than we normally would. But it's not like they've been pulling forward demand. But if you look into the future, the more robust pipeline and backlog gives us better visibility as we look into next year.

Great. Thank you.

Our next question comes from Paul Chung with JPMorgan. Please go ahead.

Hi. Thanks for taking my question. So just to follow up on margins, you know, if we think about EBITDA margins, kind of X freight costs, maybe you are kind of in that mid-20s percent range. You mentioned maybe some, you know, temporary costs come back, but is this kind of the more normalized margin profile? We should expect maybe in, I don't know, second half of 22 when some of these costs fade a bit and, you know, as your software product mix continues to accelerate, can we see further expansion there? Then I'll follow up.

Yeah, Paul. So, I think if you look back to our track record of driving, we have a track record of driving profitable growth. I mean, we'll exit the year around 23 percent, and that's a 150 basis point improvement from where we exited 2019, despite the transitory cost increase. We do believe EBITDA margin can go higher, and we have many levers to achieve that. You mentioned one, you know, scaling new markets that have traditionally richer gross margin, whether that be software, or the fixed industrial machine vision markets we're entering, along with the team continuing to driving higher margin and productivity through the operational efficiencies across the business, which we've always done. So again, we do expect margins, EBITDA margins to improve beyond this year, particularly as the transitory freight abates.

Thanks. And then your free cash flow in the quarter pretty much paid for Fetch. So, you know, your flexibility to continue kind of inorganic expansion is really quite good. You know, debt level is in a good place. You know, where are you looking to kind of expand the portfolio and, you know, what leverage levels are you comfortable with? Reflexus and, you know, those driving higher margin software mix, should we continue to expect priority on software kind of moving forward as well? And then you mentioned adaptive vision as well, if you could provide an update on how that business is going.

Yeah, so I'll start on the M&A side of this. You know, M&A continues to be a priority for us. We are certainly very excited about the outlook for the business, and we do see M&A as a vector for growth. We're quite pleased with the recent acquisitions of Fetch, Antwit, and Adaptive Vision as well. We look at M&A as a way for us to accelerate our strategy to advance our enterprise asset intelligence vision, and we're targeting select bolt-on acquisitions as well as some high-growth acquisitions that would truly advance our EAI vision. We see opportunities in digitizing and automating supply chains and workflows more broadly. And as you said, we have a strong balance sheet that can support our M&A opportunities. Then on adaptive vision, that's part of our machine vision fixed industrial scanning solution set. We acquired them back in Q2, and they provide software solutions that help our customers to design in machine vision or fixed industrial scanning solutions in their workflows and to be able to more easily extract useful information from their digital images that they take. And so it's an integral part of our machine vision solution and helps to make sure that our solutions are easier to implement than our competitors. So it's one of our value propositions. And so far, we're very excited about the overall entry into that market.

Thank you.

Our next question comes from Brian Traub with William Blair. Please go ahead.

Hey, good morning. We've had such great momentum in a number of end markets. I'm wondering, Anders, are there any end markets where the impact of, you know, COVID-related sales and, you know, sales stimulated by the pandemic has been delayed? And, you know, in end markets where it's not going to be really a headwind or like a tough comp in 2022 where maybe it's the rental car market or healthcare market that, you know, kind of took a while to get going. Do you see any end markets that, you know, just have yet to really drive growth as it relates to the pandemic where we'll see incremental growth in 22?

The pandemic has really accelerated a number of secular trends that's supporting our business and helping to drive enterprises to implement our type of solutions. You know, the themes around how to digitize and automate our customers' businesses is a, I'd say, a high priority across all our vertical markets, across all the end markets and geographies. how to, you know, improve frontline worker efficiency and, you know, reduce frictions from those workflows. So, I don't think there's any, I can't think of any meaningful market that would be hampered by, you know, this environment or kind of really lagging from this. This is a pretty broad-based picture. You know, we did see early on during COVID say that healthcare was hit hard because they, you know, the traditional acute care business was for healthcare provider largely shut down. And if it wasn't truly acute, they wouldn't admit patients and it became only taking care of COVID. But that has rebounded and we're now, you know, surpassing 2019 levels.

Can I interject and just say, I don't think I asked the question as clearly as I wanted to, but do you see any end markets where you look at the end market right now and say, okay, that's starting to kick in, whereas it hasn't to date, where you're excited about incremental growth going forward?

Anders, would you like me to?

Yeah, I'll take just a couple of comments on this and see. There are certainly areas that at NGO HEAL you can provide some extra color. I just highlight one market I think that we can see that is starting to kick in, and that will be hospitality. You know, hospitality was largely shut down for most part of COVID, and that's coming back. And we do see a number of, you know, a pipeline for opportunities within the hospitality segment is recovering nicely. And Joel, you have some other ideas.

Yeah, I was going to mention three, one perhaps that you might not expect. Hospitality is one. Another one that has sort of a longer curve where we expect benefits to continue is manufacturing, which has been recovering really nicely. You saw that already this quarter, but we expect that to continue. There's much to be recovered there. And a third one that you might not think of would be Japan. Japan has been a market that has been on the sidelines for a bit, in particular during the pandemic. But many of the Japanese customers have not yet migrated to Android. And now that they are seeing the recovery from the pandemic, they're doing that. So there's a market opportunity there that is extending strongly, we believe, into the next year.

What percentage of revenues in Japan roughly today?

It's a small part of our revenue stream today, but it's a nice upside opportunity for us. Right.

Okay. And then just the last question on software. Are you able to give us an update since there's been so many acquisitions and growth in software and you're making the comments that the margins are being aided by higher, you know, the overall margin being aided by higher margins in software today? Where are you in terms of, you know, the size of that software business? I know you don't kind of shy away from saying percentage of total revenue historically from software, but I'm just curious if you could give any comment on that or, like, when do you envision software being 5% or 10% of sales down the road? Any quantification or clarity on that would be helpful.

Yeah. So if you look at our software or the SaaS portfolio of the business, it's still, you know, small, mid-single digit as a person of the company. And we haven't stated a target or an aspiration in terms of what's the right mix. Obviously, it's an area of the business we expect to grow organically faster than the core business over time. And that's a priority from an M&A perspective. But in terms of we haven't, we don't have a set date in terms of what percentage of sales we want to get to, you know, by a particular year, except for, again, to continue to build out the suite of offerings we have and turn it into a driver of organic growth. Thanks for taking my question.

Our next question comes from Keith Halsom with North Coast Research. Please go ahead.

Good morning, guys, and congratulations on a good quarter. I want to revisit the supply chain challenges once again. Is there a feeling that the supply chain challenges are kind of peaking now and perhaps are going to slow way to recovery, or we're not quite sure if they've peaked quite yet and we still have to work through it?

There are different parts of supply chain challenges here now. You know, I talked a little bit about the semiconductor issues. We also have more logistics issues around, you know, ocean freight and air freight. I would think that on the freight side, I would expect a quicker recovery, and I would expect that to moderate as we get into the first half of 2022. So I think we're probably at peak rates and capacity constraints, but not that there will be a kind of binary improvement in this area, that it goes from whatever it is today to what it was prior to COVID. It will be a gradual improvement, I think. On the component side, I think we're... We wouldn't expect it to get any worse, but I think, again, as I mentioned earlier, we would expect kind of gradual improvements by mid-2022. Does that help?

Great. It does. And then the component side, is it primarily with chips, or does it seem like the issues are popping up and it's kind of playing like whack-a-mole, and you've got one issue here that you may resolve, but you go to a different issue?

I think it's largely on the semiconductor side, but it does move around. So we secure, so backing up on steps. So even before COVID, even before this, every quarter when we started, we would have certain parts that were on allocation or that we needed to find more. So that's a normal part, but the number of parts today is much higher. And while we work on and solving problems for one part the next week, some other part pops up. So the frequency and the number of parts that are on allocation or longer lead times is greater. But we try to make sure that we work very closely with our semiconductor suppliers to let them know what our true requirements are. And we've signed long-term supply agreements, price agreements, and so forth to make sure that we get proper consideration when they do allocate the parts. And, and, uh, but it's a, you know, it's, it's a, um, it's a complex process, but I think we've been managing it very well so far.

Great. I appreciate it. And then moving over to the software, you know, you've had it for Lexis now probably for, you know, at least a part of a year. Um, in terms of the approach to, uh, the sales, is it sold direct primarily as a direct deal? And is it the same as your regular Salesforce or do you have a different software Salesforce? And then how does Antwit go to market, and how do you envision selling these things together going forward?

So I'll start, and then Joe Hill can provide some extra insights here also. But for Reflexus or our broader software portfolio, we have set up dedicated software sales teams within our broader go-to-market organizations. So you can think of our traditional account management teams would be able to start a conversation, you know, qualify an account to some degree, and then bring in our software experts to do a lot of the more technical part of the selling activities. But that is in a more dedicated part of the organization, make sure we have the right level or depth of knowledge and insights. We are doing this largely direct today, but we are also working with expanding our portfolio, our partner portfolio here. And there's a number of other type of resellers and system integrators who are interested in working with us to be able to represent us and participate in doing implementation services. We're specifically with Antwit here now. We are initially keeping the Antwit sales team somewhat separate because we want to make sure we keep the focus and dedication to that, but leveraging, again, the account team's access to accounts as well as the broader expertise we have in our software go-to-market side. Joe?

I think you said it well. I have nothing to add.

Okay. That's good. Great. Thanks, guys. Appreciate it.

Our next question comes from Damian Carrasque with UBS. Please go ahead.

Hey, good morning, guys. Good morning. I think you've covered a lot of ground. You did highlight particular strength in mobile computing, I think most notably in Europe. Maybe you could just elaborate on what you're seeing that's driving that. To some extent, is this a matter of Europe just catching up? Are there any particular end markets, customers, or outsized projects that are driving that mobile computing strength in Europe?

Yeah, I'll start again, and Joe can also add some extra colors on Europe. But first, I'd say we're very pleased with Q3 as overall. We've seen great demand, and we've just been able to drive our revenues to exceed the high end of our guidance range. And our customers are aggressively pursuing digital enterprise transformation strategies, which is causing problems us to basically exceed our expectations as far as revenue growth this year. We talked about the supply chain issues as being a moderator on this, but we've still been able to deliver double-digit growth across all the regions and each of our product segments. And we continue to see strong growth from both our smaller customers as well as our large strategic accounts. based on our performance, I clearly expect that we are continuing to take share in the industry. And we, you know, we entered Q4 with a strong backlog, and we have a healthy pipeline, which I think provides good visibility into 2022. Specifically for Europe, I think we saw, you know, Europe obviously had a fantastic quarter, you know, saw strength in nearly all the subregions of EMEA. And growth was across all our verticals with particular strength in transportation logistics, and that was driven by some very attractive large postal services wins. And retail was also very strong vertical for us. From a product perspective, mobile computing and services were particularly strong, while the printing business was more impacted by supply chains. Joe, any further comments?

Yeah, I would say that the strength in Europe was perhaps a little bit of an artifact of us trying to get the optimal mix of supply that's available to the customers that we have. If you look over more than one quarter, you'll see that the strength in North America and Europe is pretty much exactly on par. So we're seeing equal strength in both over two or three quarters here. This was more of a one quarter artifact, I would say.

Understood. That's really helpful. And, you know, I guess we've all seen the headlines since last quarter on Honeywell's actions taken against Debra. Investors do have some questions on this. Anders, maybe you could just kind of give us an update on the ITC case and that pending litigation. How would you expect these matters to play out?

You know, first, we have a policy of not commenting on ongoing litigation. So it's hard for me to provide a lot of color, as much color as I'd like here. But clearly, we have a, we plan to vigorously defend our positions here. And, you know, I'd like to just remind everybody that we have the broadest and deepest intellectual property portfolio of the industry. And we will remain laser focused on extending our lead and taking share in the market and to beat our competitions in the marketplace.

Okay, great. Appreciate it. Best of luck, guys.

Thank you.

Our next question comes from, or our last question comes from Rob Nathan with Baird. Please go ahead.

Yes, good morning, and nice job on the quarter as well. A lot of ground's been covered. I was just, I was curious, though, if you could delineate your growth by channel during the quarter? It sounds like both sides, both run rate business and, and large, uh, large, um, deal business were both strong, but I was curious, you know, how each one might've waited out. Um, and then maybe your, if you could comment as well, just on how the backlog, uh, strong backlog that you mentioned as well, how that might be weighted between those channels.

Yeah, I'll, uh, Joe, do you want to take the lead on this? Joe?

Yeah, sure. I can take the lead if you like. So, in the past quarter, our direct channel mix was slightly higher than in the past. So, we had a little bit more in our direct business rather than our channel business, but our channel centricity, so the percentage of our business that goes to channel remains extremely high as is our strategy sort of in the over 80% range. And our backlog continues to be very strong as we entered into the current quarter. We've had a very strong backlog again, and we're already building backlog for future quarters, as you might not be surprised to hear.

Does the backlog favor large deal versus the channel? Do you draw a distinction? Generally, yes.

Yes, generally more for large deals, yes.

Okay, okay. And then a number of nice wins that you commented on during the quarter, one in particular, the U.S. home improvement win. I'm just curious, was that a – were you the incumbent in that account, or was that a competitive takeaway?

In this case, we were the incumbent. Yeah, we were the incumbent, and there was a refresh of an – of an earlier Android implementation.

Yeah, maybe it's where I was headed with the question, because I recall that was one of your maybe larger, or I think you had a large early win in Android with Home Improvement Retailer in the U.S. And I'm just curious, are you starting then now to see refreshes more broadly on your Android installs? And if so, I'm just curious if you can make a decision you know, a stronger determination around how the life, I guess the lifespan of those devices is varying versus legacy devices.

Yeah, so we are definitely seeing a number of our customers that were early adopters of Android now upgrading or refreshing to second generation Android. And the, you know, the, The refresh cycle for Android devices is a little faster than it was with Microsoft. The level of innovation on the platform is higher. So you can think of the number of new Android versions coming out is quite frequent, and they tend to require more memory, faster processor speed to run properly. And that, combined with our customers putting more and more applications on the devices, So that also drives more memory as an example. So there's a number of things that are causing our customers to want to upgrade and refresh their portfolio at a faster pace than what we saw with older Microsoft platforms.

And you mentioned as well that's going to a broader set of users at that customer. I'm just curious if you could You know, is there an order of magnitude that you could speak to?

Yes, definitely a much deeper penetration of devices into our customers' operations. You know, the value of having every worker be digitally connected and aware is a priority, I would say, for virtually all our vertical end markets, but particularly in retail and healthcare. We've talked about how today, roughly, our estimate is that one-third of retail store associates have access to a mobile device. And when we talk to our retail customers, they certainly have an aspiration to get that to be much, much higher. And similarly, in healthcare, we did a vision study, I think it's a couple of years back now, where The expectation there was to bring it from about 60% up to 95% over the next few years.

Great, great. Thanks for taking the questions.

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.

To wrap up, I would just like to thank our employees and partners for their extraordinary efforts to drive or to serve unprecedented customer demand in a supply-constrained environment. And while we are focused on maximizing profitable growth in the business, our top priority continues to be the health and safety of our employees, partners, and customers as we recover from the pandemic. We would also like to wish a warm welcome to the Antwit team. Thank you, and have a great day, everyone.

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