Michael A. Steele - Vice President-Investor Relations Anders Gustafsson - Chief Executive Officer & Director Michael C. Smiley - Chief Financial Officer Joachim Heel - Senior Vice President-Global Sales.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker) Paul Coster - JPMorgan Securities LLC Jason A. Rodgers - Great Lakes Review Keith Housum - Northcoast Research Partners LLC James E. Faucette - Morgan Stanley & Co. LLC Matthew Cabral - Goldman Sachs & Co. Jeremie Capron - CLSA Americas LLC Brian P. Drab - William Blair & Co. LLC Andrew C.

Spinola - Wells Fargo Securities LLC.

Good day, and welcome to the Q2 2016 Zebra Technologies Earning Release Conference Call. All participants will be in listen-only mode. 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 thank you for joining us. Today's conference call and slide presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Mike Smiley, our Chief Financial Officer. Anders will begin by discussing our second quarter highlights and key drivers of the results.

Mike will then provide more detail on the financials and discuss our 2016 outlook. Anders will conclude with an update on Zebra's 2016 strategic priorities and an overview of our vertical go-to-market strategy. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions.

This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission.

During this call, we will make reference to non-GAAP financial measures as we describe business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release. Now, I'll turn the call over to Anders..

Thank you, Mike. Good morning, everyone, and thank you for joining us. We are pleased with our overall performance in the second quarter, which reflected sales in line with our expectations as well as strong gross margin expansion, lower operating expenses, and improved profitability.

We achieved $144 million of adjusted EBITDA, a 10% increase over the prior year, and adjusted EPS of $1.34, which exceeded our guidance range. We continue to make solid progress on the integration of the Enterprise business.

I am particularly pleased with our progress on the improvement plan for services margins and realizing meaningful product cost reductions, both of which were key contributors to our gross margin outperformance.

From a sales perspective, as expected, macroeconomic uncertainty combined with a slow IT spending environment has continued to elongate the sales cycle. It is important to note, while some customers have delayed projects into future quarters we have not experienced any increase in order cancellations.

Conversely, Zebra's strength, scale, and robust solutions have enabled us to further extend our market leadership during the past quarter. Of note, mobile computing and scanning were particularly strong from a sales and margin perspective.

A key driver is our leading portfolio of Android-powered devices and solutions, which now represents more than one-third of our mobile computing sales volume, as customers upgrade from legacy operating systems. Turning to our regions.

North America was flat on a year-over-year basis, which was an improvement in trend from the first quarter as the compares were slightly less challenging for that region. We saw lower sales in our EMEA region from the same quarter a year ago as we cycled over double-digit growth last year.

Good growth in Northern Europe was offset by softer sales in Eastern and Southern Europe and the Middle East. Our Asia Pacific region generated record sales and approximately 10% growth year-over-year. China, our largest market in the region, continued to grow double digits, aided by new business from the largest online retailer in the country.

Japan also recorded strong double-digit growth. In Latin America, revenue declines have moderated as we continue to navigate a challenging market. We have also begun to see the benefits of organizational improvements, as well as proactive sales generation activities we have implemented.

From a vertical perspective, we experienced the strongest growth in transportation and logistics or T&L, which has benefited from our innovative visibility solutions, as well as increased parcel delivery driven by e-commerce growth.

Retail, our largest vertical, declined largely due to the slower IT spending environment we discussed, and sales to manufacturers were also lower. In healthcare, we once again saw double-digit growth as we capitalized on attractive opportunities within this sector. Our vertical expertise and focus remains a key differentiator for Zebra.

I will provide some more detail on how we will drive growth in each of our primary verticals a bit later on this call. Looking forward, we are reiterating our full year 2016 outlook, which assumes no material change in the current operating environment.

As we look at the bigger picture, while we expect near term sales performance to be impacted by customers pausing decisions in an uncertain environment, we continue to have a healthy pipeline and believe we have a commanding position in the global marketplace.

Organizations around the world are recognizing the opportunity to adopt visibility solution like Zebra's to drive growth, improve productivity, and reach higher levels of customer service. I will now turn the call over to our CFO, Mike Smiley, to review our financial results in greater detail and discuss our 2016 outlook..

Thanks, Anders. As you can see on slide 5, adjusted net sales for the second quarter were $882 million, approximately flat year-over-year on a constant currency basis. Enterprise sales were $577 million, up approximately 1% year-over-year on a constant currency basis.

Sales increased in mobile computing and data capture, whereas services and wireless LAN sales were lower than last year. In Q2, we booked revenue from our first Trailer Load Analytics order, an innovative solution we discussed last quarter.

Pre-transaction Zebra sales were $305 million, down approximately 3% on a constant currency basis against 17% growth in Q2 2015. Performance within our Printer business was solid and the sales decline was due to an especially large order from a retail customer last year. Supply sales increased while location services decreased versus the prior year.

Sales in North America were flat, with growth in the Enterprise segment offsetting a decline in the pre-transaction Zebra business. EMEA declined approximately 4% from a year ago on a constant currency basis as we cycled strong sales performance in Q2 of last year.

Sales in Asia Pacific grew 10% in constant currency, led by growth in all major product categories, as well as strong performance in China and Japan. In Latin America, sales declined about 4% as a result of a continued difficult macroeconomic environment.

We drove further growth in Mexico, our largest market in the region and have positioned ourselves well for promising opportunities there. Our adjusted gross margin of 46.4% exceeded our forecast and was 190 basis points higher than in the prior period.

We benefited from a strong mix, continued improvement in services margins and delivering on our cost reduction programs. Additionally, keep in mind that in second quarter of last year, we incurred product rebranding and various other costs in the Enterprise segment.

Operating expenses for sales and marketing, R&D and G&A were $285 million including $3 million of stock-based compensation expense. This reflects a decrease of $10 million compared to the prior year primarily due to lower stock-based comp expense and reduced sales and marketing and R&D costs.

Favorability was partially offset by increased G&A cost including tax advisory fees and $4 million of litigation expenses. Other operating expenses were $10 million lower than the prior year.

This included both acquisition and integration and exit and restructuring costs of $39 million as we made progress on our IT integration and restructuring efforts related to the October 2014 Enterprise acquisition. Amortization of intangible assets were $60 million.

The ERP and broader IT implementation is going well and has been on budget and on schedule through the first half of the year. Our Phase 1 Asia Pacific deployment has gone well and we continue to assess and monitor the implementation as we plan a roll out to the remainder of our global operations next year.

In other areas of the integration, we invested approximately $20 million more integration expense during the first half of 2016 to meet the requirements for certain key business and function-specific activities.

These included changing and integrating the Enterprise business flows into the Zebra model, legal and restructuring, and integration of the new channel partner program. The scope and cost changes were executed to ensure smooth transition and deliver the desired operating results.

In Q2, we successfully launched PartnerConnect, the industry's premier channel program. And as you saw in our Q2 results, we have a consolidated operating structure that is delivering a lower tax rate than was possible utilizing the legacy Enterprise operating model.

The investment for these projects is behind us now, and despite additional costs, remain on track to achieve our $300 million debt pay-down for this year. As a reminder, in late Q2, we successfully repriced our term loan, reducing the rate by 75 basis points.

This action reduces our interest expense going forward, but negatively impacted interest expense in the second quarter of 2016 by nearly $2 million on a net basis due to one-time impacts of accelerated amortization and transaction fees. In the quarter, non-GAAP EPS increased to $1.34 compared to $1.03 in the second quarter of last year.

A lower tax rate, impacted by cash adjustments and estimated changes to related profitability mix by jurisdiction, positively impacted the second quarter of 2016 non-GAAP EPS by approximately $0.14. Second quarter 2016 adjusted EBITDA margin was 16.3%, an increase of 170 basis points in prior-year period, primarily due to higher gross margins.

There was a negligible impact to EBITDA margin on a year-over-year constant currency basis, but I think it's worth noting that Q2 EBITDA margins would have been approximately 300 basis points higher using the exchange rates as of the close of the acquisition in October 2014. Turning now to the balance sheet and cash flow highlights on slide 6.

We ended the second quarter with $141 million in cash and cash equivalents, which includes $116 million held outside the U.S. At the end of Q2, we had approximately $2.9 billion of long-term debt on the balance sheet. The debt was used to finance the October 2014 Enterprise acquisition, and we've been paying it down aggressively.

Year-to-date, we have made $145 million in total principal payments and our net-debt-to-adjusted EBITDA ratio has decreased to approximately 4.5 times. Zebra has a strong liquidity profile.

There are no near-term debt maturities, and we have an undrawn $250 million revolving credit facility with no financial covenants unless we have more than $50 million drawn at the end of any quarter.

In the first half of 2016, we generated $122 million of cash flow from operations which significantly exceeded the $20 million in the first half of 2015. Total capital expenditures were $35 million compared to $49 million in the first half of 2015.

In the first half of the year, we drove improvement in cash flow primarily from initiatives from reduced working capital and expect to drive well over $100 million of benefit for the full year as compared to 2015.

With respect to foreign exchange, approximately one quarter of our total company sales are denominated in euros and the vast majority of the product costs are in U.S. dollars, which exposes us to currency transaction risk from both the sales and earnings perspective.

In order to minimize volatility in financial results, early this year, we hedged approximately 80% of Zebra's net euro cash flow exposure for the entire year, effectively locking in a $1.09 euro rate. Going forward, we are adopting a rolling four-quarter hedging program and therefore already begun to implement a layer of hedges for 2017.

Although the British pound has sharply devalued since the Brexit vote in late June, it has not materially impacted our results. Our UK business represents only a mid-single digit percentage of Zebra's overall sales and has performed well on a year-over-year basis helped by some significant wins. Slide 7 shows our path of financial deleveraging.

Our top priority for free cash flow and excess cash balance is to pay down the acquisition debt to achieve an improved capital structure. We remain committed to pay down $300 million of debt this year and $350 million in 2017.

Despite this debt repayment schedule, absent a material change in the macroeconomic landscape, we are unlikely to achieve our initial net debt to adjusted EBITDA leverage target ratio of less than 3 times by the end of next year.

As a result of currency pressures and a challenging global sales environment, our original goal became very aggressive within that timeframe. That said, we will continue to aggressively manage our expenses and cash flow with our ultimate objective, continuing to be net leverage target of between 2 times and 3 times adjusted EBITDA.

We continue to make steady progress towards this target with our EBITDA growth and commitment to pay down debt. We continue to be on track with the outlook provided last quarter. On slide 8, you'll see that for the third quarter we expect adjusted net sales to be flat to down 3% from a comparable net sales of $919 million in the third quarter of 2015.

This expectation reflects a range of a 2% decline to 1% growth on a constant currency basis. Third quarter 2016 adjust EBITDA margin is expected to be approximately 17%. Non-GAAP EPS is expected to be in the range of $1.30 to $1.50. Our outlook also reflects a higher gross margin compared to the prior year period, but sequentially lower than Q2.

Also, in Q3, operating expenses are expected to be approximately flat to slightly higher than the prior year period and assume a couple million dollars of increased litigation expense. For the full year 2016, we continue to expect adjusted net sales growth to be in the range of a 3% decline to a 1% growth from the full year 2015.

This reflects an expected range of a 2% decline to 2% growth in a constant currency basis and positive year-over-year sales growth by the fourth quarter. We also continue to expect adjusted EBITDA margin of approximately 17% for the full year 2016. The improvement over the prior year is expected to be driven primarily by a higher gross margin.

We expect approximately flat operating expenses compared to the prior year. Note that our forecast includes the assumption of $8 million to $10 million in higher litigation expenses for the year with the majority coming in the second half.

Also note that this reflects a 40-basis-point negative impact to EBITDA margin for the full year 2016 based on year-over-year foreign currency changes. For the full year 2016, other assumptions shown on the slide 8 remain largely the same as outlined during Q1.

However, we expect interest expense to be $5 million lower than our previous outlook, which reflects the benefit of a lower interest rate partially offset by fees and other costs related to the June repricing. Also, the full year adjusted effective tax rate has been adjusted lower to approximately 20%. I will now turn the call back to Anders..

T&L, retail, healthcare and manufacturing. Our specialized resources and strategic relationships with industry partners enhances our credibility with customers and helps us engage as a strategic advisor higher up within their organizations.

In T&L, we are providing visibility into truck capacity and delivery optimization that translates into fuel savings and other productivity benefits for our customers.

This real-time data provides enterprises a vantage point into every area of transport operations, including the ability to maintain and monitor fleets and track drivers and shipments instantaneously.

An exciting and new innovative offering in T&L is the recently launched Trailer Load Analytics solution Mike referenced, of which a leading global transportation company is our first customer.

The solution utilizes Zebra's sensors and analytics to aggregate data across thousands of dock doors and indicates the next best action in loading operations in real time.

We also recently launched an innovative line of Total Wearable Solutions, which is the world's only dedicated suite of enterprise wearable devices built on the Android operating system. These lighter and more durable wearables free up warehouse workers' hands and eyes, allowing Zebra's solution to improve productivity and accuracy.

With regard to our retail vertical, our solutions do more than connect every aspect of an enterprise. They also connect an enterprise to its customers. This type of visibility helps to develop consistent messaging, pricing and service across in-store, online and mobile touch points, resulting in a seamless customer-centric experience.

For example, one of our high-end department store customers needed to display thousands of shoe styles and colors to appeal to its customers. The wide variety of shoes meant a complete inventory assessment could only be performed weekly, which translated into lost sales and missing display samples.

To ensure real-time display accuracy, the customer selected a Zebra RFID solution that captures full information on each shoe style. As a result, this customer achieved quicker fulfillment, reduced out-of-stocks, improved customer service and increased revenues.

Our end-to-end healthcare intelligence solutions enhance operational efficiency, staff productivity and patient safety. Zebra provides the kind of visibility that lets healthcare facilities see into every aspect of the patient journey, from admittance to discharge.

A University Medical Center in the Netherlands recently teamed with Zebra to create a system which provides time tracking, evaluation and feedback when treating heart attacks, the world's number one cause of death. This solution measures the crucial time between when the patient enters the hospital and when the appropriate procedure is initiated.

It wirelessly transmits real-time information from a Bluetooth-enabled patient ID band, providing immediate visibility into the time it takes to restore blood flow in each patient, ultimately improving patient outcomes.

In this Enterprise Asset Intelligence offering, we have connected smarter supplies, patient identification, and location-enabled wristbands with our Zatar cloud platform to aggregate and analyze collected data. This is the first step in enabling our printer supplies to become more intelligent.

As we unlock further value with Enterprise Asset Intelligence, we are identifying additional opportunities to make our supplies and media more connected and intelligent. In our fourth key vertical, manufacturing, seeing the big picture means having visibility into every moving part of the customer's operation.

With increased visibility, manufacturers can streamline processes, exceed production targets, and deliver flawless fulfillment. For the largest processor of dairy ingredients in the world, the limited scanning range of its solution was making it difficult to capture barcodes on its shipping containers and pallet stacks from varying distances.

This customer upgraded to Zebra's recently released rugged extended range scanner that can read 1D and 2D barcodes from up close to up to 70 feet away. Zebra scanners were an ideal fit to streamline processes and increase reliability, particularly within the demands of a tough industrial environment.

In another case, a global provider of water, hygiene, and energy services found it increasingly difficult to meet its service level agreements for tracking its customers' processes around the clock.

By partnering with Zebra, they were able to aggregate data from multiple sensors, which can be analyzed and promptly make improvements and keep their processes operating efficiently. The Zebra solution has also enabled more accurate reporting and reduced inventory levels.

These are just a few examples of how our unique solutions are increasing visibility, improving processes, and ultimately generating significant efficiencies across enterprises in the T&L, retail, healthcare, and manufacturing sectors. In conclusion, we remain confident in our long-term growth and profitability outlook for the company.

Over time, we expect our focus on smart investments for growth coupled with our disciplined cost structure to unlock meaningful value for Zebra's key stakeholders. As shown on slide 12, we continue to expect annualized sales growth of 4% to 5% over a cycle and adjusted EBITDA margins of 18% to 20% by the end of 2017.

Further, our commitment to pay down $300 million in debt in 2016 and $350 million in 2017 drives us closer towards our target net debt to adjusted EBITDA range between of 2 times and 3 times.

In closing, we have an opportunity to transform how organizations operate and we have a dedicated, engaged and global One Zebra team that is motivated and excited to make it happen. With that, I'll hand the call back to Mike Steele..

Thanks, Anders. We've reserved the balance of the hour for Q&A. And 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. Operator, please instruct our callers how to ask a question..

Thank you. We will now begin the question-and-answer session. [Operator Instruction] Our first question comes from Richard Eastman of Robert W. Baird. Please go ahead..

Yes. Good morning..

Good morning..

Could you speak for a minute or two just to, how the channel looks versus how your direct sales look? If I look at maybe the sales upside in the quarter, at least to our expectations, it came out of Enterprise, and I'm curious if that upside at Enterprise came from direct sales on the mobile computing side or maybe health of the channel, sell in, sell out, that type of color..

I would say the – I'll start and I'll ask Joe Heel to help out here also. I'd say our revenues were very balanced between channel and direct high-touch business.

We had a large – a healthy number of larger deals, but we also had a very strong performance in our channel across the world, and we were particularly pleased with that as obviously introducing a new channel program with as much change as to one we did, and not see a hiccup in any of the performances was a great performance.

So, we think that's a great win for us.

Joe?.

Yeah. I would add, the channel constitutes 83% of our revenue. And such, the introduction of the new channel program was particularly important for us, and as Anders said, we're very pleased that we saw strength in the channel revenues while we were introducing that new program.

So really, the channel very nicely complemented the strength of the large deals that we did see in Q2..

Was that strength kind of back end quarter loaded? I mean....

No. I think we would say the business in the quarter was pretty evenly spread. We had good momentum as we entered Q2 and it continued to just be I think, from our perspective, a solid quarter..

Okay. And this is just a follow-up question for Mike Smiley. In the $50 million of cost saved that we had forecasted for the year, I think $30 million of that was in – was targeted for the COGS line.

When we look at the gross margin on the quarter, was that $30 million largely achieved on a run rate basis in the quarter?.

I would say over the first half of the year a lot of it was achieved. There's still some to be realized in the second half..

Okay. Thank you..

Our next question comes from Paul Coster of JPMorgan. Please go ahead..

Yeah. Thanks for taking my questions. First of all, Anders, you've – you obviously look to return to growth as soon as this fourth quarter but also over the long haul. There's many dimensions to growth.

Is this from first-time adoption of a new generation of applications? Is it from market share gain? Is it from increasing the software content and raising the ASPs? If you could kind of give us some flavor of what you think the main vectors of growth are over the long haul; that would be helpful. Thank you..

Yeah. We see a lot of, I guess, first, strong secular growth trends that we're trying to capitalize on, starting from a vertical perspective, in healthcare.

Healthcare has been a strong growth vertical for us for several years, and really, the catalyst has been the electronic health records, and we expect that there's still plenty of untapped potential within that vertical, particularly in the U.S. in the short term. But over time, we expect that to become more global.

Transportation logistics has been a good vertical for us also over time. I think e-commerce continues to be a good driver, and we are for T&L also developing a lot of new and exciting solutions that are uniquely suited for T&L and to help drive more value for them.

On the retail side, there's a – every retailer that we talk to has a big program around how to drive omni-channel or enable omni-channel. And in our view, omni-channel will be at least a neutral driver for us over time. But it might be a little more choppy in the short term as some retailers have more opportunities to invest than others.

But we're seeing a lot of good opportunities or a lot of growth already from retailers that are adopting omni-channel type of strategies. So, if you think of, if you do Click & Collect or something like that in a store, it drives a totally different level of technology intensity around our products. And....

I'm sorry..

And I'd say, maybe from a geographic perspective, Asia Pac continues to do very well for us. We think it's a, we have good opportunities to continue to do well there. We believe we're very well-positioned in Europe and the U.S. also, and we are programmed to reinvigorate growth in Latin America. It feels like it's also starting to pay off.

And as a backdrop, I'd say, we are very excited about the new types of solutions we are developing around Enterprise Asset Intelligence to really help our customers get greater visibility into their operations to drive productivity improvements and enhancements to their service levels..

This is Joe Heel. I'd like to add one more dimension to the sources of growth, and that is that we continue to be in the middle of and, in fact, driving technology transitions in three major areas. The first one is the transition in mobile computing from legacy operating systems that requires migration of operating systems.

There's over 50 (35:32) million mobile computers that need to migrate off Windows CE and Windows Mobile platforms by the end of 2020. And as you know, we're leading that transition, we had a very strong market share position in that transition in the first half and even in the last year.

The second is in scanning, where the transition from 1D to 2D scanning is one that we are now leading, and the third is in printing where the transition from – where the expansion into mobile printing is providing lots of new growth opportunities for us..

I got more than I anticipated it. Separately, the – Anders, you talked to that, projects being delayed rather than being cancelled.

In which verticals are they being delayed? And how are the customers – but why are they being delayed and how are the customers justifying it? I mean, assuming that they've got a three-year to five-year payback on these investments, delaying doesn't seem to make an awful lot of sense, but explain it to us, please?.

Yeah. I think, it's a few different reasons for that. I'd say, Q1, it was a lot to do with budgets hadn't been fully allocated out to the business units. So, they weren't necessarily in a position to go forward with some of those projects.

In Q2, I'd say, it was more that many of our customers were saying there were a lot of things going on and they needed to pull back and be more focused. So, they didn't want to take on more projects than they felt they could realistically execute on. So, they were being more, I guess, diligent about which ones they picked and focused on.

And, I said, that was probably more from a retail perspective where there's a lot of things going on within retail around omni-channel activities. So, those would be the – probably the top priority thoughts around that..

If I could correlate it with you. If you looked at the holiday season, which is of course, the key season for retailers, last year, it really was a very mixed season with some clear winners and some clear losers as you can say retailers that struggled to keep up.

And as a result, as they entered into Q1, some of these retailers then went into introspection and reconsidered their plans for the coming year. That's not unusual, but because the Christmas season was so split in performance, I think it led to the reconsideration of some of the spending plans in Q1 in particular.

Some of it spilling over into Q2 and the rest of the year..

Thank you..

Our next question comes from Jason Rodgers of Great Lakes Review. Please go ahead..

Yes. Just a follow-up on the retail discussion.

Would you say that the environment overall for spending in retail improved in 2Q versus Q1 or did it pretty much remain about the same?.

No. It was definitely stronger. We saw good improvements, sequential improvement particularly in North America and it was both around traditional brick and mortar retailers, as well as e-commerce. And we certainly see e-commerce as a category to become more and more prominent within our overall retail category..

And, can you give us an update on what was saved thus far with the ES integration and the expected savings for the second half of the year?.

Yeah. So, the full integration is expected to be completed in the middle of next year. I would say that we talked about the fact at the beginning of the year we saw $50 million of synergies coming through, of which $30 million was going to be cost of goods sold and $20 million was operating expense.

Operating expense is primarily a full year impact of the things that were done last year. The cost of goods sold, as we said, a good chunk of it was realized in the first half, and we'll still realize some in the last half..

Thank you..

Our next question comes from Keith Housum of Northcoast Research. Please go ahead..

Good morning, guys. Thanks for the question. Hey, Mike.

What was the gross margin split between enterprise businesses and printing businesses this year – this quarter, I'm sorry?.

Obviously, our gross margin in our printing business is always – has been traditionally higher than it has been in the enterprise business. If you look at it, what we do is we do – you will see the Q, the operating income will come in that area going forward.

I think one thing we want to make sure you realize is that we're very pleased with the gross margins in those trends. We're realizing the benefits of the cost reduction initiatives, associated procurement, design to value, service margin improvements, more favorable sales mix.

We also have – gross margins within mobile computing were particularly strong. These are a result of, obviously, multiple quarter efforts. And we expect the trend to trend positively. I will say that we did see sequential improvement in the gross margin on the enterprise business, which I think was favorable..

Okay. We saw that the tax rate is changing for the year. Is there any change to your long-term guidance for that tax rate? I think you were previously between 22% and 24%..

Yeah. I think it's going to be probably closer to 25%-ish long term, but it's not changed dramatically..

20% this year and any thoughts to how it – I guess you scale up to 25% over the long term?.

Yeah..

I'm sorry. You got 20% this year, long term 25%.

Is it going to go up sequentially every year for several years? How do you think we get to that 25%?.

Yeah, it'll go up sequentially every year..

Thanks..

Our next question comes from James Faucette of Morgan Stanley. Please go ahead..

Thank you very much. Just a couple of questions for me. First, I think you've talked about cost improvement being an important driver of gross margin. But I just want to make sure that – we were a little surprised with printing being weak that gross margins came in above target.

Was that all related to the cost reduction efforts, or were there other mix or other items that really benefited that we should be aware of?.

The – yes. Printing was slightly weaker from revenue year-over-year but it was due to a really tough comp last year. There was one particular deal that we couldn't replicate. If we had been able to replicate that we would have seen growth.

But the margin profile across the business, though, is quite steady, and the improvements we see there is really, goes back to all the efforts we put into driving improvements in gross margin or reductions in cost of goods sold.

So, we've had a very deliberate initiative around procurement and design to value also for printing, but also for our enterprise product since we closed on the transaction. And we're now starting to see those programs or initiatives starting to bear fruit.

Service is another area that we put a lot of emphasis on improving margins, which is also nice to see that that's now coming through..

Got it. And then when you look at – one of the key objectives, going back to the Motorola Enterprise acquisition, was looking for opportunities to sell multiple product lines into customers.

Can you give us an updated idea of how successful you've been thus far and what your customer base looks like, that may be buying products, multiple product lines now that weren't before?.

Yeah. I'll start and I'll ask Joe to help out also here. I'd say we have seen lots of good opportunities for our better-together story resonating. You can go – from a high level I look at healthcare. That has been a focused area for Zebra for a long time but not so much for Motorola.

We have made healthcare a focused vertical for the entire business and we're seeing great growth for both mobile computing and scanning in there. And I'd say similar in retail, we are seeing new wins for printing in retail where we didn't have before.

So, that's how – the strength we have on – from one part of the company across other verticals are helping to pull through business.

I'd say also the examples that I went through in my prepared remarks, each of those examples are utilizing a number of different products, and all including both Enterprise and the pre-transaction Zebra printer products..

Joe Heel speaking. I would add, we put a lot of emphasis early on in cross-training the sales force in order to be able to sell the entire portfolio and to implement initiatives and incentives that would indeed incentivize the cross-selling.

I think it's fair to report that we are seeing good traction on that, not only in the examples that Anders included in the prepared remarks, but throughout our business, we regularly see deals where both printing and our Enterprise products are included.

We are moving, in fact, I would say beyond that now to where we have – to where we are implementing solutions in our customers where we integrate those combinations of products into more of a solution. Indeed, some of the things that Anders described are examples of that.

One other thought on the cross-selling, of course, I mentioned earlier that 83% of our sales goes through partners. So, in order for us to be successful with the cross-selling, it isn't enough that our own sales force does this, but also that our partners do this. And the new PartnerConnect program is in fact helping us to do this.

If you look at the elements of the program, it provides incentives for cross-selling. It provides certifications for partners to acquire capabilities across our entire portfolio. And of course, we only launched it in April, but we're quite confident that it will help us in that ability to cross-sell..

Yeah. We're doing a lot of things to integrate the product families to work better together. So, initially, you can say there was almost like two separate products that were sold together as a bundle. But now, we've done things around how to make it easier to pair products.

But also, we're now integrating our printer products into the OVS, our cloud-based services platform, to make sure that we can manage all products, irrespective of kind of the history of them, from one platform..

Got it. Thank you very much..

Our next question comes from Matt Cabral of Goldman Sachs. Please go ahead..

Thank you. In your prepared remarks, Anders, you mentioned how Android is over a third of the mobile computing portfolio now.

Can you just give us a sense for how customer interest has evolved around the transition, both with your larger customers, as well as the more run rate business? And when do you think we'll get to the tipping point where Android is more than 50% of that mobile computing portfolio? And then, also, just thinking about it from a gross margin perspective, any sense of how Android stacks up versus the wider enterprise average would be helpful as well..

Yeah. So, the – we're very pleased with the progress on expanding our Android business. We have the industry's most comprehensive lineup of products for that and we are getting a lot of recognition for that – for product superiority in that area also. I'd say, the largest most sophisticated customers are the ones that are leading the charge.

They have their own IT department to understand what is going on with Android and Microsoft and other operating systems and can make their own decisions about what's really in their best interest over the longer term. And so, we see – I'd say, we almost exclusively see larger tenders be for Android devices.

Further down, if you look into kind of more the smaller deals run rate type of business. There I think it's a bit more inertia that people know the products they have. They have written applications around those that they don't necessarily have the resources in-house to migrate those off a legacy operating system to an Android, say.

So, we expect there to be a lag before that happens. But we do – we are seeing Androids having more and more traction deeper down in the pyramid, say.

So, it is working and we are having a number of plans for how to engage with both directly with end-users, as well as with – through our distribution and reseller partners to educate and train both resellers and end-users on these things.

And then lastly on the margins, if you look at – if you compare a large deal, say, for Android versus a large deal for a legacy operating system, the margins tend to be very similar. If you compare a run rate type of deal for Android versus a legacy operating system, they again would be very similar.

So, the difference we've seen in margin profile between Android and legacy operating system has been much more driven by the proponent (50:31) or the portion of the total revenue that comes from large deals versus run-rate..

Thank you. And then I wanted to follow up on the earlier question about deal push out. Could you just give us a sense for how many of the push out deals that you talked about last quarter's call were actually closed in the second quarter versus the percentage that are still outstanding.

And is your sense of either just timing around some volatility with your customers' businesses or are these push outs more a function of a wider re-scoping of projects where they're going back to the drawing board a little bit, and then maybe a couple or a few quarters before those actually convert into deals for you?.

So, this is Joe Heel. I'll answer that one. We were very pleased with the fact that the deals that pushed out from Q1, we were able to close a majority of those. I don't have an exact percentage for you, but we were able to close a large number of those deals.

That said, we do continue to see the caution that Anders mentioned, in particular in the retail sector and we've talked about it in some of the earlier questions. We do see some of that caution persisting. So, some deals in Q2, we saw push out to Q3. And so, we see some of that caution continuing.

But we're quite confident, to your point, that it is a matter of timing and that it isn't that people are fundamentally reconsidering their architecture and their approach. I think they're weighing the projects in the context of an altered economic environment for themselves and an altered budgeting cycle that they perhaps find themselves in..

Thank you..

Our next question comes from Jeremie Capron of CLSA. Please go ahead..

Thanks. And good morning, everyone..

Good morning..

Hi, Jeremie..

Question on the integration of the Enterprise business. Clearly, some good progress being made here between the new partner program and the cost synergies that are flowing through here. But I couldn't help but notice that you removed your guidance for one time integration charges in 2016, 2017. I think you had $130 million to $150 million planned.

Is that still the case? And correct me if I'm wrong, but I think I heard you say that you spent more than initially anticipated during the quarter. So, some color around the trajectory of one time integration charges over the next couple of years would be welcome. Thanks..

Yeah. This is Mike. A couple things to your point. We've achieved a number of significant milestones thus far. Again, the Asia Pac go-live went successfully as well as the PartnerConnect. Keep in mind that as we went through those within the region, we had a 10% growth. So, I think that speaks to the fact we had good execution.

We've also rolled out aspects of our services program. So, all of those have been executed well. We look at sort of the integration spend in two buckets. One is IT-related, which is hooking up the systems to run the business. The other is non-IT or integration costs.

The IT piece is on track and on budget at this point, and the non-IT expense was running about $20 million higher than the first half of 2016. We wanted to make sure that there was smooth execution. I think we've demonstrated that in the results that we have.

Want to make sure that these things include the operating model by which we run the company, the legal entity structures. Again, this was a carve-out, very, very complex, structuring the PartnerConnect program to accomplish the things that are important for both us and our partners.

We also had corporate rebranding as we move from a Motorola name to a Zebra name consolidated. Those types of things. I think it's important to note these additional costs that are non-IT are behind us. The integration expenses have peaked.

We expect a step-down going forward, and we remain committed to a debt pay-down goals of $300 million in 2016 and $350 million in 2017..

Great. Thanks for that. And in terms of the new Chinese e-commerce customer that you mentioned and there's, it sounds like it's an interesting win that you scored here.

Can you comment around the opportunity for Zebra in China? How much runway do you see for growth and how much of that could be imminent given what's happening in that e-commerce sector in China? Thanks..

So, China has been a fast-growing market for us for a long time, and we have a very strong team I think in China. So, we're putting a lot of emphasis, a lot of effort into making sure that we have the right strategies for the long-term including making sure we have the products to support the Chinese customers.

So, we are very excited about what China can do for us and how we can continue to grow in China. We've definitely seen our footprint expand over time, so when we first entered China, it was very much based on really Western manufacturing companies but over time we moved into a lot of the local manufacturing.

But over the last few years we have seen a lot more retail particularly e-commerce as well as T&L, of course all those e-commerce packages need to be delivered somewhere. We've also seen actually quite strong healthcare growth.

So, the portfolio of products we sell in China is now much broader, it starts to be much more similar to what we see in the U.S. and Europe as examples. Maybe....

Yeah. I'd add two other opportunities for growth that we're pursuing and have been pursuing in China. It's been really a growth story that's extended over many quarters for us now. The two others are – is cross-selling. We talked about that a bit earlier. We have strength in different sectors between the pre-transaction Zebra and the Enterprise business.

Enterprise, as Anders was saying, having charged into the retail segments, the e-commerce segments, fast-growing areas where the printing was very strong traditionally in manufacturing. We now have the ability and are in fact cross-selling between those two. So, that's one very nice source of growth.

And then the other one is, we have the opportunity to expand geographically within China, right? So, you have multiple tiers of cities, we're quite present already in the larger cities like Shanghai and Guangzhou and Beijing. But the second and third tier cities are ones we are in the process of penetrating and staffing.

And so, we have lots of growth in that dimension as well..

Thanks very much..

Our next question comes from Brian Drab of William Blair. Please go ahead..

Okay. Thanks for letting me sneak in the question here. On Android, one-third of your mobile computing sales is a really impressive result going from essentially zero a couple of years ago.

Given you've introduced these new products so recently, I'm wondering if there's an opportunity to improve your margins on those products going forward, just given the nature of when a new product is introduced, there's typically design work than can be done to take costs out of the product and improve your margins there.

So, any comments on that opportunity?.

Yeah. Absolutely. This goes into the broader initiative we have around gross margin improvements. So, both – we're working on both regular procurement activities. So, working very closely with our contract manufacturers or JDM Partners to make sure that we get the lowest product cost we can from that perspective.

But we also, having a number of this, what we call, design to value initiatives going on. This is where we take an existing product and look at ways to how we can redesign it, to design cost out of the product to reduce the product cost and improve margins.

Both of these initiatives were meaningful drivers for the gross margin over performance that we had in Q2 here, and that included also on Android devices. So, we see clearly working very hard to make sure that we are very thoughtful and focused on improving margins in our Android portfolio..

Okay. Thanks. And then for Mike Smiley maybe, the selling and marketing expense has averaged $121 million over the previous five quarters. You're at $112 million in the second quarter.

Where should we model going forward, closer to the $112 million or the $121 million?.

Yeah. I think that as you look at that, we tend to look at – we obviously have a bottoms-up detail and we'll end up with – for example, adjustments to stock-based comp and stuff like that it sort of goes up and goes down. So, we tend to look at the – as we look for reasonableness, we tend to look at it for a total OpEx trend.

I think in Q3, we're seeing things that are driving our total OpEx going up a little bit is we have some duplicative IT costs that are going through G&A, where, for example, you have two systems that have to work at the same time until you get off the old one. We have higher litigation expense, we also have some higher healthcare costs.

Absent these costs, our total OpEx would be lower year-over-year. I don't know that sort of giving you definition of OpEx for sales and marketing and all those other things would necessarily be helpful at this point..

Okay.

That litigation expense is ongoing?.

Probably through this year..

Okay. All right. I'll follow up more later. Thanks..

And our last question will be from Andrew Spinola of Wells Fargo. Please go ahead..

Mike, can you just tell us what that litigation expense is associated with and how big it is in the second half?.

It's just related to some of the litigation associated with the acquisition of – as we did the acquisition, we ended up with – assuming some of the responsibilities for some of those items. And it's just – it's not huge, but it's several million dollars quarterly..

Got it. And then just back on the question of the integration spend, the guidance would imply a pretty material step-down in the second half here.

Can we still expect that?.

Yeah. Again, we had said I think around $130 million to $150 million for the full year. Our integration expenses have peaked. We said that our expenses for the year are about $20 million associated with the non-IT related spend.

Again, to your point, we expect a big step-down going forward, and we certainly remain committed to the $300 million debt pay-down 2016..

Okay. Thank you very much..

And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Steel for any closing remarks..

Thank you, all, for participating. Have a great day..

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