Good day and welcome to the Q4 and Full Year 2019 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] 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. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These 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 filings with the Securities and Exchange Commission.During this call, we will make reference to non-GAAP financial measures as we describe our business performance.

You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer and Olivier Leonetti, our Chief Financial Officer.

Anders will begin by discussing our fourth quarter and full year highlights. Then Olivier will provide additional detail on the financials and discuss our 2020 outlook. Anders will conclude with recent progress made on advancing our Enterprise Asset Intelligence vision.

Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales will join us as we take your questions.

Also throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Cortexica, Temptime, and Profitect businesses for the 12 months following each acquisition.

This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year.Now, I'll turn the call over to Anders..

Thank you, Mike. Good morning everyone and thank you for joining us. Our team drove profitable growth in the fourth quarter. As you can see on Slide 4, we reported net sales growth of 4.6%, adjusted EBITDA margin of 21.4%, which expanded by 30 basis points, and non-GAAP diluted earnings per share of $3.56, a 15% increase from the prior year.

We posted a record level of EPS, although it was at the lower end of our guidance range due to tariff expenses at the high end of our expectations and prioritizing a higher mix of large mobile computing year-end budget orders, each of which impacted gross margin.Our diversified business is enabling us to post solid growth despite an uneven global macro economy.

The continued soft environment in China was more than offset by growth in our North America and EMEA regions. We grew all our major verticals led by healthcare, retail and transportation and logistics. We drove double-digit growth in our enterprise mobile computing portfolio which capped another exceptional year.

Our customers utilize our mobile computing solutions for new use cases on the Android platform as we benefit from our leadership in the transition from the sun-setting Windows operating system.We also continued to drive higher service attach rates on our product sales, which bodes well for future quarters.

RFID was another bright spot in the quarter, growing strong double digits. Lower operating expenses enabled us to expand EBITDA margin, despite transitory tariff expenses that weighed on gross margin.

By mid-year, we will have a more diversified sourcing footprint, which will enable greater operational flexibility and mitigate the tariffs.In Q4, we acquired Cortexica Vision Systems to accelerate our computer vision capabilities, which I will discuss later on the call.

For the full year, Zebra delivered solid results with 5.5% sales growth, 90 basis points of adjusted EBITDA margin expansion, 18% non-GAAP EPS growth and $624 million of free cash flow. We continue to build upon our industry-leading offerings by investing in innovative technologies that elevate our role in enabling the intelligent enterprise.

We are entering 2020 with a solid order backlog and we are optimistic that we can drive another record year of performance.With that, I will now turn the call over to Olivier to review our Q4 financial results and discuss our 2020 outlook..

Thank you, Anders. Let us start with the P&L. As you can see on Slide 6, net sales grew 4.8% in the fourth quarter, which translated to 4.6% on an organic basis before the impacts of currencies and acquisitions. We saw growth in each of our reporting segments.

Enterprise Visibility and Mobility segment sales increased 6.3%, led by growth in mobile computing and support services.

Asset Intelligence and Tracking segment sales increased 1.2% with relative strength in Services and Zebra Retail Solutions.Turning to our regions; in North America, sales grew 8%, primarily driven by strength in mobile computing, services, and RFID. We saw broad-based strength across our primary vertical markets.

EMEA sales increased 4% with relative strength in mobile computing and services. Eastern and Southern Europe were bright spots in the quarter. Sales in our Asia-Pacific region declined 8%, primarily due to continued macro softness in China due to trade tensions. Latin America sales were flat.

Adjusted gross profit increased nearly 1% from the prior year period. Adjusted gross margin contracted 190 basis points to 45.8%, primarily driven by a nearly full percentage point net impact from List 4 tariffs and an unfavorable sales mix of large year-end budget orders. We view this Q4 rate as exceptional and not a new normal.

Adjusted operating expenses declined $12 million from the prior year period and improved 230 basis points as a percentage of sales. This improvement was primarily due to reduced project spend and lower incentive compensation expense, partially offset by the inclusion of expenses from recently acquired businesses.

We will continue to drive a balanced approach of driving operating leverage while making prudent investments in growth initiatives.Fourth quarter 2019 adjusted EBITDA margin was 21.4%, a 30 basis point increase from the prior-year period, including the temporary one point negative impact from tariffs.

We drove non-GAAP earnings per diluted share of $3.56, a 15% year-over-year increase, which includes the $0.16 negative impact from List 4 tariffs.Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $624 million of free cash flow for the full year 2019.

This was lower than the prior year period, as expected, primarily due to the timing of working capital items. We paid down $312 million of debt in 2019 after the funding of acquisitions and venture investments.

We ended the year with 1.3 times net debt to adjusted EBITDA ratio, which is the lowest level since the acquisition of the Enterprise business more than five years ago. We repurchased $47 million of shares in 2019.

Our strong balance sheet and cash flow profile provide us ample flexibility to invest strategically and return excess capital to shareholders.On Slide 8, we provide an update on the anticipated impacts to Zebra from the Section 301 tariffs on products imported to the U.S.

We are on track to diversify our global sourcing footprint, which will mitigate List 4 tariffs that became effective in September, impacting our mobile computers and printers. We continue to work with our contract manufacturing partners to replicate lines in order to move most of the U.S. volumes to broader Asia.

These actions are expected to result in up to an additional $25 million of one-time pre-tax charges through mid-2020 plus $10 million to $15 million of capital expenditures.

With these supply chain actions, we expect to substantially mitigate tariffs by mid-2020.In the first quarter, we expect these tariffs to negatively impact gross margin by approximately $10 million and decline to $5 million in Q2 as we launch alternate sources of supply outside of China.Let us turn to our outlook on Slide 9.

We entered 2020 with a higher-than-expected order backlog and solid pipeline of opportunities. Our contract manufacturers and all the areas of our supply chain in China have experienced delays as workers returned from the new year later than usual due to the coronavirus outbreak. Our outlook incorporates our best view of the coronavirus impact.

We expect net sales growth in Q1 to be between 4% and 7%.

This outlook assumes an approximately one percentage point positive impact from recent acquisitions and then approximately 1 percentage point negative impact from foreign currency changes.We believe Q1 adjusted EBITDA margin would be approximately 20%, which assumes improved operating expense leverage and a lower gross margin attributable to a $10 million impact from List 4 tariffs and approximately $4 million of additional freight cost due to the supply chain delays from coronavirus.

Non-GAAP diluted EPS is expected to be in the range of $2.90 to $3.10. The estimated negative impact from tariffs and additional freight cost is approximately $0.22. We assume a negligible impact from share repurchase. That said, we will continue to be opportunistic with our share buyback program.

Also, we estimate that we could have an additional $0 million to $50 million impact to sales related to the coronavirus outbreak if the situation becomes meaningfully different than expectations.We expect full-year 2020 net sales growth to be between 4% and 6%, which assumes an approximately 30 basis point positive impact from recent acquisitions and an approximately 1 percentage point negative impact from foreign currency changes.

Full year adjusted EBITDA margin is expected to be slightly higher than 22%, an improvement from 2019 as we work to drive gross margin expansion and operating leverage. We do not believe that the coronavirus outbreak, as we understand its potential impact today, will have an material impact on our full-year outlook.

We believe the risk to be mainly in timing of order fulfillment in near-term.We expect that full year 2020 free cash flow will exceed $700 million, a substantial increase from 2019.

You can see other full-year 2020 modeling assumptions on Slide 9.With that I will turn the call back to Anders to discuss the progress we are making on our Enterprise Asset Intelligence vision..

Thank you, Olivier. We are optimistic about our business as we enter 2020 and we believe we can continue to successfully navigate an uneven global macroeconomic environment. Now turning to Slide 11. We collaborate closely with customers to transform their workflows, so that they can achieve their strategic goals.

The value proposition we bring to the market has translated to sales growth in each of our primary verticals for Q4 and the full year. In healthcare, our fastest growing vertical, we are addressing a broad set of challenges that hospital systems are facing across their operations.

These challenges range from bedside care to the management of medical supplies and equipment throughout their supply chain.

As an example, we have been rolling out mobile computing solutions to the National Health System in the U.K., enabling digitization at the bedside to treat patients, which improves the level of safety and generates real-time and actionable data to optimize the entire supply chain.For manufacturers, Zebra addresses their needs across their business.

These include planned floor productivity enabling the smart warehouse and optimizing field operations. Our solutions are resonating with customers because we can demonstrate a positive ROI for our solutions even in a challenging environment.

We are excited that multiple prominent manufacturers in North America recently deployed multi-million dollar Android mobile computing and printing solutions to help maximize their productivity in B2B workflows including direct store delivery.In the transportation and logistics space, our customer staff are overextended and their end customers expect service and information instantly in an increasingly on-demand economy.

The success we are seeing in this vertical is attributable to the real-time visibility we are bringing to our customers' supply chain, which enables them to increase productivity.I would like to call out our team's success in becoming a partner of choice for nearly all of the largest postal systems around the globe, including the US Postal Service, which will begin to deploy our mobile computers in the second quarter.

We empower postal carriers with the mobile technology to increase productivity by scanning, tracking and tracing packages across their network with high level of data security.In retail and e-commerce, omnichannel fulfillment is a critical area where retailers are making significant investments.

RFID has become an increasingly important option to improve omnichannel capabilities because it can deliver close to 100% inventory accuracy. As more and more items are source tagged at the point of manufacturer, RFID gains momentum. We are currently deploying an RFID solution to several hundred stores for a major apparel retailer.

This customer conducts daily scans of the entire store with handheld RFID devices in less than one hour, which is driving increased sales uplift and lower inventory shrinkage. This customer has also purchased several thousand of our combination RFID readers and barcode scanners for their point of sale transactions.

We are pleased with the strategic relationship we have forged with this customer as we collaborate on proofs-of-concept to address additional in-store use cases that can improve their top and bottom-line results.Now turning to Slide 12.

As a trusted strategic partner, we orchestrate the end-to-end workflows for customers in the primary verticals that we serve. Last month at the National Retail Federation Expo, we showcased how we accomplish this in retail and e-commerce through a full suite of innovative solutions.

These solutions address many operational challenges our customers face as they reinvent their business models.

Prescriptive analytics, machine learning, computer vision and mobile computers for all associates are a few key enablers to intelligent retail that we featured at the show.Advancements in technology now allow retailers to generate an unprecedented amount of frontline data on their stores through mobile automation systems, shelf edge cameras, mobile computer scans, inventory, point-of-sale, RFID and other sources.

This heavy flow of information is actionable in real-time with our software solution.Zebra prescriptive analytics, formerly known as Profitect analyze massive data streams utilizing machine learning to identify variations in the data in real time.

The most impactful recommendations are instantly prioritized and sent directly to workers' mobile devices to take action for optimal outcomes. We have deployed our proven offering with many leading retailers including the Home Depot, Walgreens, Family Dollar, ASTA, REI, Ahold Delhaize and many more.

Computer vision capabilities are becoming an increasingly important component of our offering in retail and other vertical markets we serve.In Q4, to further accelerate our capabilities in this area, we acquired London based Cortexica Vision Systems, whose talented engineering team has been developing vision-based analytics and artificial intelligence solutions that include object recognition through machine learning, image and video analysis and visual search.

At the NRF Expo, we introduced solutions with our innovative computer vision capabilities, including a flatbed scanner that can visually identify fruits and vegetables, as well as our new intelligent automation solution SmartSight that features a robotic vision system which rolls through store aisles.

The system can identify critical issues such as stock-outs or price discrepancies and direct a worker through a mobile computer to correct the situation.

We plan to leverage our enhanced computer vision capabilities in next generation offerings to address emerging use cases in markets that we believe represent a multi-billion dollar opportunity.We were proud to feature Office Depot at our booth this year.

They demonstrated how they have deployed Zebra's purpose-built mobile computing solutions to empower their associates to transform the customer experience and improve operational efficiency across their stores and distribution centers. Their solution includes our Workforce Connect software application for efficient collaboration among associates.

There is a strong and growing trend at many retailers to equip all their associates with mobile devices that enable collaboration with co-workers and customers. We are ensuring that we have the appropriate purpose-built portfolio of mobile computers for our enterprise customers to empower their entire workforce.

We featured some of these at NRF and we expect to roll out additional offerings later this year.In closing, our core product offering continues to resonate well in the market. We are broadening our role as a strategic solutions provider, partnering with our customers C-suite.

And we are continuing to invest in capabilities that digitize and automate enterprise operations. We've opened large, new attractive market opportunities for Zebra including intelligent automation and computer vision applications, new point-of-sale solutions and mobile devices for all. 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..

[Operator Instructions] The first question will come from Jim Ricchiuti of Needham & Company..

Hi, good morning. Thank you. Two questions, first, I wanted to just talk a little bit about the strength you're seeing in the order book entering 2020, I'd like to know, particularly, which areas of the business and geographies.

And then I have a follow-up question as it relates to some of the color you're providing with respect to the coronavirus risk. So just on -- first on the areas of the business where you're seeing the strength. It sounds like good strength in RFID, but I wonder if you could talk a little bit more about it and the sustainability of that strength.

Thank you..

Yes, thank you. First, I think we -- our team executed very well in Q4, we were up almost 5% and that was on top of a 9% growth in 4Q '18. So we had a very tough compare. We saw very solid performance in North America and EMEA. That was offset by softer spend environment, particularly in China.

We did see particular strength in our mobile computing portfolio, but also in services and RFID, as you mentioned.

We grew all our vertical market -- verticals that we serve, led by healthcare as the fastest with strong double-digit growth followed by retail transportation logistics and manufacturing and for the full year 2019, all verticals we're up also.

So we have a very diversified business which is enabling us to post solid growth despite now being in a more uneven global macroeconomic environment. And I guess lastly, we're quite confident that we grew share in 2019..

And so you see those trends as with respect to your guidance-- those same trends are playing out in your Q1 outlook..

Yes, I think we have a good outlook for the first quarter of 4% to 7% growth. And that's over an 8% growth of the last year.

We entered the year with a solid backlog, we have healthy inventory levels in the channel and so we expect now faster year-over-year growth starting to kick in here faster than Q4, and we continue to see North America and EMEA as the strongest geographies for us and we also currently expect China to continue to show softness.

I don't know, go-to-market side, I think we have good discipline around our offerings and pricing and our value proposition continues to resonate well. For the first quarter, though, we aren't expecting the USPS to participate, that roll out will start in Q2..

Okay. Thank you, Anders for that. And just with respect to the coronavirus, I think we all appreciate the challenges of trying to forecast the business with these fast moving developments.

But I'm wondering, as you see the business now, are you -- does your guidance for Q1 anticipate any revenue potentially shifting out into Q2? I mean, you've highlighted some additional freight expense and then the $0 million to $50 million impact that you identify on sales, is that -- I wonder if you could talk a little bit about whether that is more supply chain related or potentially demand related that you're anticipating.

Thank you..

Let me answer to this question, Jim. So as you indicate that the situation is obviously very fluid. We have new news every day. Our base case or the 47% growth for Q1 assumes the impact of the coronavirus as we know it.

So for example, we have reflected shifting demand, lower demand in China, additional freight cost and to give you a bit more colors on what is going on with our supply chain, our teams are taking their pills pretty much multiple times a day, all our Tier 1s, our key partners are back to work and ramping productions.

Our Tier 2 partners are largely back to work and ramping production every day. And our supply chain is operating with some manageable bottleneck. So the situation is fluid and we believe we can manage the impact of the virus as we know it. If we were to have an impact in Q1, we don't think it would be the case, on top of what we put in the guide.

We believe that the impact will be timing and that our full year guide would be intact.Now, let me comment on the additional $0 million to 50 million additional potential risk on the top-line. Again, that's not our expectation.

Our expectation is that we would be able to mitigate the impact of the tariff as we know it, but if the ramp of our production was not to be as per our expectation, we wanted to give you some bookends about the potential impact and we size the impact to $0 million to $50 million, again would be timing if that unlikely scenario was to materialize..

Okay, then just one thing to add to that. We've talked on earlier calls about our supply chain diversification strategy to mitigate the impact of tariffs. So our manufacturing in Vietnam and Malaysia for printing and mobile computing is now ramping up and would have an impact on the quarter also..

Thank you..

The next question will come from Meta Marshall of Morgan Stanley..

Great, thanks. Maybe first question just on -- you mentioned the USPS deal coming in, in the second quarter. And just maybe what explicit you've built into the year as far as that deal, just given the size and magnitude. And then maybe second question just -- you're below kind of your net debt target at this point.

So just how -- and you are going to generate a meaningful amount of free cash flow in the next year. So just how are you thinking about use of free cash? Thanks..

So, yes. Thank you. I'll start with the USPS part. So first, we are very proud of our USPS win. That's a big win for us and it augments the relationship we had with USPS. They were already customer of our other product and solutions before.

The specific solution helps the USPS optimize the visibility of package delivery and also the execution across their carrier network. This is a multi-year contract. It's the largest in the history of the company and I think it highlights the strength of our value proposition here.

The award includes our TC77 mobile computers, Mobility DNA, some custom software, as well as, managed and professional services.

The ramp-up is -- it will start in Q2 and the -- our outlook assumes the majority of orders will be deployed in 2021.We've taken a prudent view here and only included the orders that we have visibility into our 2020 outlook. As the U.S.

3G cellular service providers will be ending 3G service at the end of 2021, that is definitely a consideration for the roll-out cadence and we expect that the USPS will basically be done by, with the entire roll-out, before the end of 2021 to make sure that they have devices they can work on, on the 4G network.

And I said -- maybe come back to that later, but we won a lot of other good postal service wins that Joe can pick up on..

Yes, just as additional context, right, postal services around the world are making the transition that many of our customers are making from Windows-based to Android-based devices and we've been fortunate to participate in and win the largest tenders in each of the four regions we participate in.

In Asia, we won the largest deal, which you know about with Australia Post, in Latin America, earlier in 2019, we won the largest deal there. And recently we've also won the largest deal in the European postal system, all of which have transitioned to our Android computer. So postal service is one of those areas of strength for us at the moment..

Let me cover your cash allocation question. So as you indicated, as you related to, our leverage ratio at the end of the year was 1.3 times net debt to EBITDA, the lowest since the Enterprise acquisition.

Our business has a strong cash flow generation, we would be investing in the business organically, but also deploy our cash through M&A and also investments in our venture fund. We also will deploy cash to a buyback program. As a reminder, we have -- we had an authorization for $1 billion buyback authorization.

We bought to date about $47 million and we would be in the market this year. We believe that, over the year, we'd buy back above 2% of the market cap of the company and we would be more opportunistic in a particular quarter, based upon the behavior of our stock price. But the guide for EPS in Q1 does not assume any impact from buyback..

Got it. Thanks, guys..

The next question will come from Brian Drab of William Blair..

Hi, good morning. Thanks for taking my questions. I just wanted to ask following those comments, Anders about the USPS. The majority of orders you said would be delivered in 2021.

This is, well, public knowledge that this is a $570 million max contract, it doesn't seem like it's impacting the 2020 year as much as -- at least I was expecting, I mean, I was thinking maybe this is like a $150 million a year and would add three points of the growth rate in 2020.

It doesn't look like you've incorporated that much in the 2020, given it's starting in the second quarter. But when you say the majority in 2021 in the contract, should we -- like those devices should be delivered by the end of 2021.

I think some people including me -- I'm being left with the impression that maybe this could be like $400 million or $300 million plus in revenue in 2021 just from this contract.

And I -- can you just help us reconcile that if I'm way off?.

Well, first the -- we have a -- basically looked at the delivery schedule that we have received from the USPS which is the baseline we have for what we've included in 2020 and that assumes that the majority of orders will be delivered next year.

Now there is certainly an opportunity that some of that can be pulled in, but that's not part of our base case, we want to -- our base case is that whatever they have told us today will be as the -- as their projected delivery schedule is what we put in our guide and our outlook. But there is -- no, there is opportunities that can be better..

But....

Yes, we will consider -- we would consider the holdup assumptions we have factored in the guide to be prudent..

Well, I need -- I'm looking for more specifics than just that. You know what I mean? I think that if you say what you said so far in the call, I guess I would reasonably model it like $400 million in revenue from 2021 from this contract..

Yes. That's the best information we can....

Is that -- and is there any shipment to this contract you think beyond 2021 or it's pretty much, you said it's done really with deliveries by the end of '21?.

In there is -- there can be deliveries afterwards, true, there includes, also, other parts of it, repairs and other services that could come with it and they have the opportunity to continue to replace damaged devices or buy beyond what they have initially said.

So the contract doesn't end at the end of 2021 and the number they have put out in the --the total dollar volume put out by the USPS envisions that this is not a two-year contract but a longer contract..

Okay.

Is it possible that you could have deliveries that total more than $300 million in revenue to this contract in 2021?.

I don't think we want to comment on the specific dollar amounts for this contract. We can kind of -- we've tried to share what we know today and what we think is a prudent outlook for 2020 and I think we have to leave it at that..

And, Brian we have also a few large accounts as part of the portfolio as well. So USPS is obviously one of them, but not the only one..

All right. It's the only one that I saw a $570 million figure associated, that's why I'm asking about it and it's the largest in the company's history, as Anders has mentioned. So, and then just where are you with the 15 -- where is the industry with the $15 million figure in terms of the upgrades? What's your latest view or comment on that? Thanks..

Yes, so the -- on Android, broadly, as I've said, we have a number of good drivers for the Android business, I'd say three clear strong drivers. First, we will be around new use cases. If you go back and look at the number of applications or use cases, our customers used mobile computers for, say five years back, it was probably mid-single-digits.

Today, most of our larger customers are probably more like 50, 60 different use cases and applications and we think that is going to continue to expand. So that's been a great driver. The Android transition from the legacy Windows operating systems continues.

There were several of the older Windows OS versions that went out of support at the end of January of this year. Our best estimate is that there is still approximately 10 million legacy Windows devices in the market that needs to be upgraded.

Our market share in Android continues to be very strong at 60-plus percent and the warehouse migration there is still gaining momentum, I'd say, and a great opportunity for us.At the second half of last year, certainly in Q4, we did start to see also, I guess, a new driver and that's Android refreshes.

So it's now five years since we started shipping Android and some of those devices are now getting ready for a refresh.

The earlier devices we had don't have the memory or processing capabilities to support all the different use cases, all the different applications our customers are putting on it as well as the processing requirements required by -- to run the newer -- the most recent android versions.And lastly, I'd say, also, as a new trend we're seeing is, our customers are looking for to deploy mobile computers much more densely or deeply into their organizations, they are looking to have basically a device into the hand of every employee, particularly in healthcare and retail.

We are expanding our portfolio of solutions to enable our customers to have the right device for the right worker, where we can then generate a positive ROI for them in those areas. We have had an order in Q4 from a large U.S. retailer, which included our new EC30 device, which was intended to be basically deployed to all their employees.

And that drives also a lot of Workforce Connect applications because most of those applications of use cases are predicated on driving greater collaboration between store employees or inter-store employees and customers..

Okay, thank you for all that detail. I appreciate it..

Yes..

The next question will be from Keith Housum of Northcoast Research..

Good morning, guys. I was hoping for a little bit more color on the guide. If -- it looks like the full year guide is actually a little bit more conservative than the first quarter.

Especially, I can appreciate the fact that the postal service will be more back-end loaded sort of 2021, but still it should add, I think, approximately a few points of growth for the third and fourth quarter and you have easier comps you are going against.

So what are you seeing on the horizon, I guess, that gives your full year guidance and perhaps a little bit lower than what we might expect based on the first year guidance -- first quarter guidance?.

So, we believe -- so as you indicated, Keith, most of the USPS order will be deployed next year. We believe that for the remaining of the year that this outlook is prudent.

It's going to be a more than respectable growth based upon what we see in the market, based upon the strength of our go-to market, based upon the strength of our product and solution offering, we believe that we should be able to deliver this prudent rest of the year guide, Keith..

Okay.

So are you forecasting processes -- the overall demand market to actually be decreased or they kind of maybe get a little bit worse? Is that part of your expectations for economic growth?.

That's not the case. So far, if you look at the performance of Zebra, Q4 of 2019 was stronger than Q3. Q1 guide is going to be stronger than Q4. So, we see an acceleration of the business. But based upon the various macro events and other phenomenon happening in the market, we believe it's the most prudent approach to guide in the way we did..

Okay. And a follow-up question for you on operating expenses. R&D was up, sales and marketing was up perhaps a bit more than we thought.

Are those increases, I guess, quarter-over-quarter, is that more due to acquisitions or was there perhaps a change in intent in R&D to increase investment there?.

So if you look at OpEx as a proportion of revenue, we have been scaling that ratio significantly every quarter, actually even more in Q4. If you look at the R&D line, we indeed add the impact of acquisitions playing out in the quarter.

But the key principle we have in mind as we manage the P&L of the company is to scale OpEx as a proportion of revenue rather than looking only at OpEx. And we have been able to do that every quarter, mainly in Q4, actually..

All right, thank you..

The next question will come from Richard Eastman of Robert W Baird..

Yes, good morning. Olivier, could you just double back for a second to the gross margin degradation we saw in the quarter and maybe just provide a little bit of color around both AIT and the EVM decline year-over-year in basis points? If you could just sift through that a little bit, you mentioned tariffs, you mentioned this large order.

Was that in the mobile computing side? And just maybe sift through that a little bit just to give us a sense of maybe that -- it's an unusual number here and not to model that kind of going forward..

Absolutely. So as you indicated, and I would go through the details in a second. The Q4 margin profile wise was exceptional and the guide for Q1 and the full year of 2020 implies us going back to normal. So going back into the details, Richard, we -- relative to the implied guide we had for Q4, our margin rate was lower by about 1 point.

As I indicated in my prepared remarks, this 1 point degradation is due to large margin orders that we have to shift to meet our customer year-end budget demands.

That impacted AIT and EVM but mainly mobile computers.And if I was to go through the various elements of impacts trying to bridge the point, the lower point we had a margin relative to our guide, the impact of higher tariffs than expectations were about 40 basis point.

The impact of higher freight as we had to expedite those large orders, the impact was about 20 basis point and the lower margin due to the mix of large orders was about 40 basis points. So you see the full impact, the full break of the one point. Now we are working all the time on initiatives to improve gross margin.

We believe we have a nascent set of activities, we will launch in 2020 to improve gross margin. We could go into the details, if you want, Richard, and we feel definitely that Q4 was an exceptional point..

Could you -- when you look out to '20, for the full year in '20 and you look at the gross margin, perhaps year-over-year, would you expect you're taking out some of the cost of the tariff and the supply chain that comes out of the adjusted number? So should we expect to see 20 to 40 basis points of gross margin improvement for the full year when we look out to 2020?.

So we believe that we will increase gross margin 2020 over 2019, net of the elements you mentioned, so tariffs and exceptional freight cost. And why am I saying that? Let me give you maybe a few examples of the levers we're using.

So from a pricing standpoint, for example, we have been addressing more and more reach verticals part of the market, healthcare being one of them, for example. We have been deploying resources to maximize, this is actually not the only one, the segment mix improvement will drive margin up.

That would be one.We're also launching a new tool, we have been piloting this tool now for about a year. The new tool for pricing transactional orders using machine learning has been launched, as we speak. We believe that, that will improve our margin profile as well.

And from a COGS standpoint, very quickly, we are designing to value our products that has been a constant with platforming also, our various products are using the same platform across various product lines and one which will have also a material impact on the margin profile for 2020 is that we have reset our service network outside North America.

And that will significantly improve the margin of our service business and now more so a material impact on the margin of Zebra as a whole. So again a nice set of activities to keep improving the margin profile of the business as we have done now for a number of years..

And just -- maybe just one last question along similar lines here, but as we have moved production out of China into Vietnam, I think you mentioned Malaysia, does -- number one, does that -- is that mostly mobile computers and printers or are there scanners being done there? And then just by definition, is that movement to Vietnam and Malaysia, do you pick up some basis points of gross margin or lower COGS on that movement out of China just structurally?.

So, I'll take this one. So first, the objective here is to move U.S.-bound volume out of China to ensure we can mitigate tariffs. We are moving out our printing volume to Vietnam, and most of our mobile computing volume to Malaysia, but also going to some other countries. On the scanning side, that was already outside of China.

That was in -- we manufacture our scanners in Mexico and in Taiwan, primarily. But with these programs looking to wrap up by middle of this year, we would expect to largely mitigate all the tariff impacts.From an ongoing gross margin perspective, we think of them as neutral today, while, say, labor cost might be a little lower in Vietnam.

Early on, we will have a little bit more freight cost moving piece parts and other components into Vietnam. But over time, we will work on making sure that we get that to be an improvement to our gross margins..

Okay, excellent. Thank you..

The next question will come from Paul Coster of J.P. Morgan..

Hi, this is Paul Chung on for Coster. Thanks for taking my questions. So just a follow-up on mobile computers. Are you still kind of selling Windows-based mobile computers and is that kind of keeping the opportunity at 10 million units? And then you mentioned you're seeing more Android refreshes happening, suggesting maybe a lifecycle of five years.

Is this kind of a shorter lifecycle than your legacy products and what are the main factors kind of driving that refresh, assuming this contribution is quite low at the moment kind of relative to your new deployments? if you could confirm that as well. And I have a follow-up..

All right, I'll see if I -- hope that I can remember. I'll start with the -- if we are selling Microsoft devices into the markets still? And the answer is yes.

We -- I think it was 2017 for us where we switched over to make Android at the highest volume of our business, but we do still sell and support our customers who have existing deployments of Microsoft devices. But it's fair to say that I don't -- I can't think of a large new customer that have selected Windows.

It is basically to service the existing installed base of those accounts and over time, they are -- I would say, they are all looking to migrate to Android. Now we have the, I'd say, the highest proportion of our volume in Android.

So if you look at other players in the industry, they are still selling more Windows devices and some of them are selling more Windows than Android even. And if you look at some markets like Asia, Windows is still quite a strong platform there.

It might seem a little counterintuitive as some of those software packages have gone out of support, but that is what we're seeing.So on the one hand, we are eating into the 10 million legacy devices by shipping new Android devices, but on the other end of that volume, we and others are adding new Windows devices also..

And just to complement, we see that as a positive trend. We have been able to post a strong sales performance in mobile computing despite the market still buying a lot of Windows due to, as we said earlier, new use cases, and also a device for hold being a new trend in this part of the market..

And I'll also touch on the Android refresh and then I'll ask Joe Heel here to add in some more color. But on the Android refresh, we started shipping our TC55 and MC40s about, give or take, five years back.

Those devices bode on the, say, longevity in the market, wear and tear, but maybe more so based on the memory capacity processing speed and so forth are no longer able to support our customers objectives.

Our customers are looking to deploy many more applications which all use memory and processing speed and also if you're looking to upgrade to newer current Android versions, they all require more memory and more processing speed.So -- I think this is a fair comment around Android overall that the refresh rate will be higher than for Windows devices.

There is a lot more innovation going on around the Android platform than there was historically even when Windows was, say, a fresh and the default operating system platform for the industry. So we do expect to see a higher level of Android refreshes than we did on or shorter lifecycle for our Android devices than we did for Windows..

Yes. Perhaps there's some additional color on that. I think you are seeing five-year lifecycles at this point, but we do see customers making their ROI calculations often with three-year time horizons now. So we do expect that the life expectancy that our customers will have will trend in that direction.

And if you think from the customer perspective, you'll -- we would say -- we would cite three things that customers are saying are driving them to these refreshes. One is applications.

There is a significant increase in applications that customers are putting on our devices where they originally may have used to adjust for inventory management, now they use it for a customer application, they use it for voice communications.

There is a significant increase of those applications.Number two, with those applications come new demands on the technology. The technologies need more memory, as Anders was saying, in addition to the inherent technology requirements, driven by the ongoing Android upgrade cycles, Right? Those are on very short 18 months or so intervals.

And then the last piece is reuse cases that are being put on devices all the time where they're being used for purposes that five years ago were not even being envisioned. So all three of those are driving the increased refresh -- shorter refresh cycle and increased refresh volume..

Thanks for that.

And then switching gears on new products, particularly the kind of new automated robots you were showcasing at NRF, do you have any kind of customers highlighting that solution in groceries, and are you seeing any kind of actual demand to deploy these solutions or are we kind of bit early? And then if you could also provide an update on SmartPack solution for trailers.

Do you see any momentum there? Just kind of want to get a sense for solutions in the pipeline, kind of newer solutions and which ones you think will have the biggest impact in the near term. Thank you..

First, I'd say that our new solutions is going to be Intelligent Edge-type solutions, have been growing very nicely for the last several years. So obviously off a smaller base, but the growth rate has been quite attractive and met with our internal expectations for 2019. At NRF we showcased a number of new solutions.

We had our SmartSight solution with our EMA robot. We had our MP7000 flatbed scanner with color camera, we had Smart Edge with our heads-up displays, so you saw a number of new solutions that are quite different from the type of solutions that the industry has offered before.

On SmartSight, first that -- we've been developing that for several years, we have it in pilots with some large customers. So we certainly expect that there'll be demand for it.

We are working with a number of our customers to figure out how can we be best introduced into their environments.And our Smart Edge with the heads-up display, that's, I think, a very attractive solution.

It helps to really modernize the whole interface with warehouse management systems and drive great productivity improvements and the heads-up display is just one way that we can render those benefits, but they can be done in a variety of other ways also. And I think, Joe, can add some additional value on how we've been doing with customers on these..

Sure. So first of all with the -- you also asked about SmartPack. SmartPack is one of the solutions we have great expectations for. And we introduced that with a large U.S.

lead customer where we have a very broad deployment with tens of thousands of dock doors deployed and we now have several other customers that are piloting this in an advanced mode and we have one customer now in Europe, which is a significant milestone to take this to another continent, that is broadly deploying this across their European network of thousands of dock doors.

So we're confident about the SmartPack solution being one of the successful ones.The other two that are worth mentioning in our IEF portfolio of solutions are RFID. RFID, we've had this in the prepared remarks, has been extremely strong for us for quite some time.

We believe this solution has reached a tipping point and the other one we would mention is Workforce Connect as a solution for collaboration that leverages our mobile computers has also been a very strong solution for us in across multiple large customers..

Thank you very much..

The next question will be from Andrew Buscaglia of Berenberg..

Hi, guys. A quick question on -- so you made the comment that you saw some more share gains in 2019, which is -- it's -- I think that's fairly well known, but it's sort of a double-edged sword in that I'm trying to get a sense on your pricing and your pricing power this year.

Do you have concerns that your competition will maybe use pricing as a lever, and I guess what fortifies you from side stepping that?.

So, if I understood you correctly, you're asking if our competition is using pricing as a lever to compete against us?.

Yes. And if that is a concern of yours, given you're selling....

Yes, well, it's a competitive -- first it's a competitive market. We are working in some very attractive but competitive markets and price is definitely a factor. Now, that's not new. I wouldn't say that pricing is any more competitive today than it has been historically.

We try to differentiate ourselves by making sure that we have the best solutions, first and foremost, and we tend to win with a premium over our competitors.

So we -- I think our -- for a variety of reasons, the breadth of our solutions, the innovation around our solutions and some of the uniqueness that we have that others can't match, enables us to get that extra premium. It's not intimate, but it is a meaningful premium. And then, Joe, maybe you....

I'll add two things. So we do pay significant attention to the subject of pricing. I'll give you two specific examples or data points. One is in the mobile computing area where we have the majority of -- we have had some of the significant share gains, we talked about earlier.

The majority of those deals are done on, what we would call, a price concession, so special prices given to our customers. And we have a great discipline within the company of managing those price concessions.

And so we pay a lot of attention to that from a sales management perspective.The second thing you heard in the prepared remarks that we're introducing some capabilities in the pricing area and we are deploying some software and capabilities that allow us to manage pricing at a very granular level, precisely because this is a very important lever for us..

Got it. Okay, that's helpful. And, Olivier, you mentioned pushing more into the software and services.

It's obvious that's kind of the route you guys are going long term, but do you care to talk about or do you have an internal vision or target of where you see that as a percentage of your portfolio? And then, I guess, what's the strategy? Do you still want to get out with more products like more things like SmartSight before you really go all-in focus on that side of the business or will we continue to see software kind of roll-out in tandem with products?.

So, if you look at the service and software part of the portfolio, it has been, particularly this year, growing at a higher rate than the overall company average.

The reason for this, as you start to have a sense, is based upon all the new capabilities we are launching and being as a company, a true orchestrator of our customer's workflows and that drives an increase in the revenue for this part of the market, but also an increase in the profile for -- margin profile for the company overall because of this impact.

Where that could go? Those markets are large and we are excited about our ability to win and play in those markets..

All right, thanks guys..

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

Thank you. We are committed to supporting our employees, customers and partners as we work through the coronavirus situation. We are optimistic about 2020 and we see much opportunity ahead.

I am grateful and excited that our Zebra team and trusted partners have positioned us for continued success.I would also like to welcome the Cortexica team and the talents they bring to our organization. Have a great day, everyone..

Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day..