Good day, and welcome to the Third Quarter 2020 Zebra Technologies Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead. .

Good morning, and welcome to Zebra's Third Quarter Conference Call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year..

Slide 2 conveys that the forward-looking statements we make today are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. .

During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. .

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

This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our acting Chief Financial Officer. Anders will begin with our third quarter results, then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook.

Anders will conclude with progress on advancing our Enterprise Asset Intelligence vision and trends in our end markets. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. .

Now let's flip to Slide 4 as I turn the call over to Anders. .

Thank you, Mike. Good morning, everyone, and thank you for joining us. We are honored that our solutions are empowering frontline workers in the battle against COVID-19. I am proud of our employees' resiliency and focus on serving our customers' critical needs during these challenging times.

Our top priority continues to be protecting the health and well-being of our employees, customers and partners as businesses continue to progress with their reopening plans. .

In Q3, our results continued to be pressured by the global macro environment. For the quarter, we realized net sales growth of 30 basis points; adjusted EBITDA margin of 20.3%, which contracted by 240 basis points; and non-GAAP diluted earnings per share of $3.27, a 5% decrease from the prior year. .

As a result of excellent execution by our teams and a faster than expected recovery in demand, each of these measures exceeded our outlook. Demand from our large strategic customers has been at record levels, driven by accelerated trends to digitize and automate workflows.

Not surprisingly, the pandemic has disproportionately impacted our smaller customers in certain end markets, which has resulted in a significant shift in business mix. Together with premium shipping costs, this has weighed on gross margin.

In light of this pressure, we have continued to diligently manage discretionary costs to preserve profitability and cash flow. .

Despite the challenging environment, our enterprise customers have been prioritizing spend with Zebra, and I would like to highlight some notable Q3 success stories. We expanded our relationship with a leading e-commerce retailer experiencing significantly increased order volumes.

They require trusted technology solutions that enable improved supply chain and order fulfillment execution to empower their labor force. We are deploying our mobile computing, scanning and printing solutions across their growing global footprint.

Innovation, quality and value are critical partner attributes cited by this customer, and we are proud that our team is delivering to their high standards. .

The hospital system in Denmark has chosen to replace a competitor with our clinical point-of-care solution. In Q3, they began a multi-quarter deployment of our health care-purposed TC5 Series mobile computers and accessories, which will interface seamlessly with their electronic medical health record system.

We have continued to deploy TC7 Series mobile computers to USPS postal carriers as planned and are now pausing through their peak holiday season, expecting to resume in late Q1 with the goal of completion by mid-Q3. .

We are proud that we are able to help our customers meet their mission-critical needs in an increasingly on-demand economy. We continue to view acquisitions as a vector of profitable growth for Zebra and a way to elevate our role as a solutions provider. In early September, we closed on the Reflexis acquisition.

In a few minutes, I'll elaborate on how this acquisition is synergistic to our offering. .

With that, I will now turn the call over to Nathan to review our Q3 financial results and discuss our Q4 outlook. .

Thank you, Anders. Let's start with the P&L on Slide 6. Net sales increased 30 basis points before the modest net impact of currencies and acquisitions. As Anders mentioned, large order volume was much stronger than the prior year.

This was offset by a decline in small and midsized business through the channel, which disproportionately impacted printing and data capture. Our Enterprise Visibility & Mobility segment sales increased 4%, driven by solid growth in mobile computing and services.

Our Asset Intelligence & Tracking, including printing and supplies, continue to be most impacted by the global recessionary environment with sales decreasing 7% from the prior year. This was a notable 18-point sequential improvement from the Q2 decline. .

We realized solid growth in our managed and professional services and Zebra retail solutions. Location solutions declined from last year due to lower project activity during the pandemic. We realized significant sequential improvement in each of our regions from Q2 as we continue to recover from the peak of the pandemic.

In North America, sales increased 6%. Mobile computing and data capture returned to solid growth, and services continued to perform well. .

EMEA sales were flat. Services and mobile computing were bright spots. We also continued to see strength in Central and Northern Europe. Sales in our Asia Pacific region declined 13%. China was a bright spot, returning to modest growth. Latin America sales declined 20% with all major product and service categories declining. .

Adjusted gross margin contracted 390 basis points to 43.8% driven primarily by more than 3 points from unfavorable business mix and nearly 1 point from premium freight cost, which was partially offset by improved services margin. Underlying margin trends across the business, excluding mix dynamics, remain healthy.

Adjusted operating expenses declined $17 million from the prior year period and improved 150 basis points as a percentage of sales. This improvement was primarily due to disciplined cost management and lower compensation expense while preserving our planned investments in the business. .

Third quarter adjusted EBITDA margin was 20.3%, a 240 basis points decrease from the prior year period, driven entirely by lower gross margin. We drove non-GAAP earnings per diluted share of $3.27, a $0.16 or 5% year-over-year decrease. .

Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $482 million of free cash flow in the first 9 months of 2020. This was $106 million higher than the prior year period, primarily due to a lower use of working capital as well as our expanded accounts receivable factoring program. .

Our balance sheet is strong. From a debt leverage perspective, we ended Q3 at a comfortable 1.8x net debt to adjusted EBITDA ratio, 0.5x higher than last quarter, due to financing the acquisition of Reflexis. .

Now turning to Slide 8. We have demonstrated that we can deliver solid results in a challenging economic environment while continuing to invest in our future.

Our consistently strong free cash flow generation is driven by our capital-light business model, flexible cost structure, diversified end markets, strong execution and disciplined cost management. .

Let's now turn to our outlook. We are encouraged by the faster-than-expected recovery with small and midsized businesses and are beginning to realize the benefit of pent-up demand from many customers who have paused their spending earlier in the year.

Based on these trends and our healthy channel inventory levels, we expect Q4 adjusted net sales to increase between 3% and 7%. This outlook assumes an approximately 150 basis point additive impact from the acquisition of Reflexis and a neutral impact from foreign currency changes. .

We believe Q4 adjusted EBITDA margin will be between 21% and 22%, which assumes modest operating expense leverage from the prior year.

Gross margin is expected to be slightly lower than last year, reflecting higher large order mix in a soft but improving macro environment as well as an offsetting year-on-year impacts of premium freight and tariff expense. Non-GAAP diluted EPS is expected to be in the range of $3.70 to $3.90. .

You can see other modeling assumptions on Slide 9. Note that we now expect free cash flow to be at least $650 million for the year, which is higher than 2019. .

With that, I will turn the call back to Anders to discuss how Reflexis is synergistic with our Enterprise Asset Intelligence vision as well as trends in our end markets. .

Thank you, Nathan. Slide 11 highlights how we are building on our foundational capabilities to elevate our value proposition with customers as a solutions provider. Our unmatched access to frontline operational data from our vast installed base of products uniquely positions us to solve our customers' complex challenges at the edge. .

We are investing in emerging technologies that help our customers better orchestrate their workflows by leveraging real-time data to gain actionable insights. We are excited to have Reflexis onboard, which further helps Zebra bring our Enterprise Asset Intelligence vision to life for retailers and other end markets. .

Reflexis is a demonstrated leader in intelligent workforce management and task execution. Their platform is utilized by hundreds of retailers around the globe to drive employee productivity and retention while also improving customer engagement. Reflexis is synergistic with our existing suite of solutions as a service. .

SmartCount, which is an innovative self scan and physical inventory management solution; our SmartSite robotic solution, which uses automated intelligence to help identify issues on the store shelf in real time; our Workforce Connect data and voice communication and collaboration application for mobile workers; and Zebra Prescriptive Analytics, which provides data-driven insights and a prioritized list of prescriptive actions that help maximize efficiency and reduce shrinkage.

.

Zebra's suite of solutions work in unison with our product portfolio to provide real-time contextual tasking. This capability is critical for successfully addressing the inevitable unplanned events that occur throughout the workday.

Over the next few quarters, we will continue to invest in the seamless integration of Reflexis' market-leading platform with our complementary software offerings to optimize the experience for frontline workers. We are also investing in our go-to-market efforts to drive accelerated traction with our unmatched suite of solutions.

We believe that our enterprise customers will realize a compelling ROI by empowering all of their associates with these solutions. .

On Slide 13, we provide an update regarding the mixed impacts we are currently seeing in the primary vertical markets that we serve. We also highlight the exciting longer-term opportunities in our end markets as customers invest in our technology in an increasingly on-demand economy.

Trends are improving since our last quarterly update, although it is still a mixed picture depending on the sector. .

In health care, our solutions helped hospitals intelligently flex their capacity to serve patients. There was a pause in noncritical care during the peak of the pandemic, straining the budgets of health service providers, which is changing now that elective procedures are assuming.

Longer term, the need for increased real-time visibility into the entire patient journey and the demand for innovative solutions to provide safe and efficient care continue to make health care a high-growth end market opportunity. .

Retailers are prioritizing investment in our technology for their complex omnichannel fulfillment strategies and related warehouse automation needs. Demand from large retailers is at record levels as e-commerce and buy online-initiated transactions have increased dramatically through the pandemic.

We have also begun to resume business with many department stores and specialty retailers that have been reopening their doors. .

In the transportation and logistics space, strong e-commerce growth continues to drive parcel volumes and last-mile delivery, which is favorable to Zebra. Passenger airlines, rental car providers and other related businesses remained challenged. The manufacturing sector continues to be most impacted with COVID-19 and global trade tensions.

Key segments within process manufacturing, such as food and pharmaceutical companies, have held up relatively well, continuing to operate through the pandemic.

We've seen mixed trends in discrete manufacturing with those in aviation and discretionary specialty goods, particularly challenged, a bright spot is our solid recovery in Chinese manufacturing. .

In closing, we are successfully navigating through this challenging environment while we continue to invest in advancing our Enterprise Asset Intelligence vision. This is enabling Zebra to emerge from this crisis in a stronger competitive position.

We also believe that our longer-term prospects are strengthening as secular trends to digitize and automate workflows have accelerated. .

Now I'll hand the call back over to Mike. .

Thanks, Anders. We'll now open the call to Q&A. [Operator Instructions].

[Operator Instructions] Our first question will come from Tommy Moll with Stephens. .

Anders, I wanted to start on the Reflexis deal.

Could you articulate for us how important integrating software as part of your revenue mix will be going forward? And what are some of the strategic rationales? In other words, what does that allow you to do in terms of increasing stickiness with the customer relationship? What are the other advantages it brings to Zebra?.

And then as a related point, as you do head into more software-driven sales, should we think about that market as one that's more competitive than where you've traditionally competed? Or how do you want to frame up the competitive dynamics there?.

Yes. That's good. I'll start, and then I'll ask Joe Heel to help out also. First, just -- Reflexis is a great company. We're very excited that it's part of our portfolio, part of the Zebra family here now.

I mean it's been a demonstrated leader in intelligent workforce management and task execution for many years, and it's been deployed by hundreds of retailers around the globe to help drive employee productivity and retention. .

And many, many of those customers are common to Zebra and to -- also to our Zebra Prescriptive Analytics solution. So when we look at Reflexis and Zebra Prescriptive Analytics and other software solutions we have, we see them as being very synergistic with our overall solution. .

If you think of our framework around Sense, Analyze and Act, I think that's probably the easiest way maybe to show how we think about creating more complete solutions for our product customers.

But we have had historically a great strength around the sense and some in the analyze part, but being able to sense what's happening in the physical world has been kind of our foundation. .

But over the last few years, we have expanded our capabilities around the analyze and the act side quite a bit, and both Zebra Prescriptive Analytics and Reflexis are examples of that.

And now when we -- prior to actually the acquisition of Reflexis, we had a number of customers ask us to do more tight integration between Zebra Prescriptive Analytics and Reflexis. They felt that, that would be something that would help get more value out of those investments. .

Zebra Prescriptive Analytics is going to continue to feed actions into Reflexis' action engine to help combine all the different actions that the retailer might do in a prioritized way. And then we look and leverage our other software assets like Workforce Connect to be able to let it all tie it back into our mobile computers.

So our store associates can either scan items in the store or enter other data that can be fed into ZPA or into Reflexis but also then be receiving updates or actions from that so that the Reflexis system can deliver even greater value by being able to do that. .

And for Zebra as a whole, with our suite of solutions as a service, we can become more strategic to our customers. We can start enabling them to address more complete workflows. And by that, we can increase the ROI of our overall solutions and be a more strategic thought partner as they think about how they develop their business.

So we definitely feel that this is a very compelling path for us and very excited about what we can do with this.

Joe, you want to add something?.

Yes. Perhaps I'll underline two things that you touched on.

One is the fact that we're synergistic, not just on the product level, as Anders described, how we think we can bring together the different product capabilities we have, but certainly also on a go-to-market and sales level, where we have a very strong share in the retail market already, and bringing Reflexis to those retail customers is immediate cross-sell opportunity that we have.

.

We're actually discovering that it also works the other way around. That Reflexis has some customers that they can bring us into and cross-sell that way. And that leads into the strategic opportunity that Anders described, right, which is -- Reflexis generally has a strong presence in the operations side of retailers.

And this now gives us an opportunity to solve their problem strategically. And this perhaps also addresses the second part of your question around do we see this as a more competitive space. .

Certainly, there are different competitors in the pure workflow software area. However, none of them have the capability that we have to bring together the Sense-Analyze-Act part of the EAI vision and to solve the problem holistically.

So we look at this as a space where we can now differentiate ourselves actually from both the traditional competitors that we had and the competitors that Reflexis currently has. .

Just to round out, say, I've been on the phone with many of the largest customers of Reflexis over the last month or 2, and I'd say that, formally, they are very excited about the combination.

They are passionate about the Reflexis solution, but they also see the value that a combination with Zebra and the extra resources we can have and how -- our vision for how we can continue to add value to their operations. So I think so far, it's been a great feedback from the market and from our customers. .

That's all very helpful. As a follow-up, I wanted to shift to some of the end market commentary you offered, Anders, specifically within retail and e-comm. It just sounds like some of the larger customers have accelerated their plans for the omnichannel integration or leaning into their e-commerce platforms. So 2 related questions. .

How durable do you see that trend being -- or maybe you could frame up qualitatively, if not quantitatively, how far ahead you think your current backlog gives you visibility into maintaining a robust pace of sales?.

And then moving to the smaller customers or potential new smaller customers, are you seeing anything -- not even in terms of order trends, just interest level that suggests that maybe the playing field here has expanded? If you just look around the retail landscape, they're a lot more engaged in omnichannel or talking about it at least now than there were a year ago.

So I just wonder if maybe there's a TAM aspect to this dynamic as well where it's shifted in your favor?.

Yes. I'll start, and then I'll ask Joe to add a little bit of color to it also. First, I think in this environment, our solutions have become even more critical for our customers. We are, I'd say, uniquely positioned to empower frontline workers across all our vertical end markets.

And COVID-19 has been accelerating a number of secular trends around digitization and automation, and it's probably most apparent in retail around e-commerce, around omnichannel and buy online pick up at store. .

Here, we've seen, particularly around mass merchants, grocers and e-tailers, that they have been the most -- the quickest, I guess, to pick up on this, and that's about 2/3 of our business.

But I'd say, the largest retailers have been the -- mostly been the most aggressive or the earliest to start adopting and investing in solutions around omnichannel and e-commerce. .

They have seen a great growth in their omnichannel and buy online, pick up at store businesses. And they have -- still believe that there's lots of market share that they can continue to grow and take.

So they are continuing to invest heavily in building out their capabilities and scaling their capabilities compared to where it was, say, just 6 months back. .

For smaller retailers, they -- I'd say generalizing a bit now, they were maybe not quite as quick to invest in omnichannel capabilities. It's a big investment and a complicated one at times.

But I think the COVID-19 and the changes in customer buying behaviors and the step-up in change in how comfortable consumers are with omnichannel and buy online, pick up at store, as an example, has made it, I think, abundantly clear for smaller retailers, too, that if they want to compete, they need to build these types of capabilities. .

So we see the pipeline of business around these larger trends around digitization, automation and particularly in retail as quite robust. And we think that this is a trend that will be going on for quite some time.

And we're just saying that, I think for now, we see then the pipelines of these types of opportunities as we look into 2021 as being as robust as we would have expected them to be in prior years at this time.

Joe?.

Yes. I'll add perhaps 2 thoughts. I do think there is a TAM expansion that's going on, but I see it a little differently than you were perhaps suggesting.

One big area of -- it has to do with the fact that in order to enable all of these omnichannel capabilities, you need a deep capability in the company more broadly than just at the front where the items are being picked up. .

And 2 things in particular that you need to do that, I think, favor us in this case is, number one, you need to enable your associates in your store because that's where most of the instant omnichannel capabilities is being created. And that means you need to digitize and give every worker a device in some form, and we're far from that today.

So that's a TAM expansion. .

And the second piece is you need to extend that modernization into your supply chain, and we're seeing a lot of activity in terms of digitizing and automating the supply chain, and that's clearly related to this acceleration of e-commerce. .

Next question comes from Jim Ricchiuti with Needham & Company. .

Follow-up on that some of the last commentary that you were making, Anders. And it sounds like you're still anticipating a fairly robust environment with your larger customers. So it's not as, potentially, there's some digestion from the investments that they have been making.

And then as it relates to the small medium segment of, it wasn't if -- to what extent you are seeing a recovery there? I mean, is there the potential over the next 1 to 2 quarters that you could have both areas of the business, both large accounts and the SMB, actually moving in a consistent fashion toward stronger growth?.

Yes. First, I think we're seeing a faster-than-expected improvement in our end markets, and we're cautiously optimistic about how the economy will recover into 2021. I think here, our industry leadership and our investments in our business will also enable us to rebound stronger than our competitors.

And to that point, that's why we feel confident to guide for a both top and bottom line growth in Q4. When we looked at our Q3 performance here, our run rate was improving. It's not back to pre-COVID-19 levels, but it is definitely improving and strengthening. And I think that was something we saw globally.

And our large deals were obviously very strong in Q3, but we still have a good pipeline into our larger customers and how they're looking to invest in Q4 and beyond.

Joe, do you want to add anything to this also?.

Yes, perhaps just 2 things. If you look at our pipeline as an indicator, it's as strong as it was on a relative basis a year ago. So we have a strong pipeline that gives us good confidence, and our run rate has been recovering.

We didn't say that clearly enough, but it's clearly a driver of the growth that we've been seeing, and we expect that to continue as well. .

Got it. And just as a follow-up question. This relates more to some reports that we've begun to see, including one by a large retailer that had been considering deploying in-store robots for inventory analysis and has now pulled back apparently on that initiative. And I know you guys have looked at that market.

But I guess my question is, if you look at the opportunities there, does it appear that it looks like some of the major retailers may opt for simply putting more devices in the hands of store personnel as opposed to maybe looking at some of in-store automation with robots and things like that?.

Yes. First, I'd say that -- I don't think that our customers see one solution as being able to solve all problems for them.

Deploying more devices or putting more devices in the hands of more associates is clearly a trend and something that our customers see as being able to drive a high ROI and enabling all of them to be connected to their applications and systems and be able to be fully utilized in that respect. .

With respect to the robot solutions, you mentioned also, we believe that there is a good market opportunity for those types of solution, in addition to using handheld computers. We have our Smart Sight solution for this, and I think that's progressed very nicely since we announced it in -- at NRF this year.

We've seen an increase in demand and pilots from any customers, particularly, I would say here now in the last few months from grocers. .

I think so far, our pilots have proven the technology, and we've been able to prove the ROI around -- just based on labor savings alone, and the accuracy of our reads have been very strong. And we -- here is an area where we leveraged our Cortexica acquisition.

So we've employed a lot of the computer vision technologies from that into Smart Site, into some of our other solutions to accelerate our ability to extract useful information from digital images. .

So we see a good, healthy pipeline of customers who are interested in piloting this solution with us. And we have pilots in North America and Europe at this stage. Although it's also fair to say that we -- COVID-19 has made it harder for us to engage on customer sites, which is making it a little slower to ramp these pilots up.

But the interest is as high as it was pre-COVID, I would say.

Joe, any further comments from you?.

I'd like to add maybe one thing here. Let's remember what were the retailers trying to solve with this robotics automation solution.

What they're trying to solve is the accuracy of inventory in the store, and there are many different capabilities and solutions that solve the inventory accuracy problem in the store, and they are suited differently to different types of store formats as well as merchandise assortments. .

And while we do believe that there is a place for the robotic inventory accuracy improvement, other solutions like RFID or simply using the data from associates' devices like you can do with Zebra Prescriptive Analytics are capable solutions for certain store formats and merchandise assortment. .

So the key, in our mind, will be having the capability to look at all of these different solutions and bring them to a customer. And that's what we're going to be in a position to do, including the robotic automation. .

Yes, I think that's a good point just on -- to emphasize, again, from -- going back to the first question we had.

This is where the breadth of our portfolio enables us to go in and talk to our customers about what is the problem you're trying to solve and then look at how can we bring our solutions, our technology to bear to best solve the problem they're trying to solve versus coming in and saying, "Okay, I have a -- whatever your problem is, my hammer is what's going to solve it." So I think this is a great example of how the breadth of our solution plays to our advantage.

.

Our next question will come from Meta Marshall with Morgan Stanley. .

Great. Maybe a couple of questions for me. One on the Denmark Healthcare win. Just any context as to -- was that your traditional kind of partner ecosystem that brought you into that deal? Was that a more health care-focused partner that brought you in? And then just maybe on the improvement that you're seeing in SMB.

Are there any particular geographies or particular type of customer that you're seeing more movement from?.

Yes. Again, I'll start and then I'll ask Joe to provide some extra color. So first, on Denmark. The Denmark health care win we had, and it's a very exciting win for us. And I would say, almost uniformly, our health care partners are uniquely focused on health care.

It's very rare that we have partners that are strong in, say, retail or manufacturing and also in health care. .

Those are very different end markets. The solutions are very different. The problems are very different. So it tends to lead to a much more vertically oriented entire value chain for us. Then around SMB, we did see improvements in our run rate across all geographies on a sequential basis.

I think that this is something we expect to -- that we'll continue to see as the economy recovers into Q4. We've certainly seen a good progression of the run rate in the SMB business here as we get into Q4 but also as we look further into 2021.

Joe, any more comments from you? Are you muted, Joe?.

I am. I do apologize. 2 comments. On the health care partners, one particular type of partner that is very important for us in the health care space are the electronic medical records companies.

We have excellent relationships with them, both from an ISV and a resale perspective, and that has been a good source of growth for us in the health care market. .

In the SMB segment, the one -- other one I would call out, in particular, is China. So in China, we've seen a resurgence, I think, of the -- in particular, manufacturing customers that are so essential for our printing business, and they have certainly contributed to the return of that business. .

Our next question will come from Richard Eastman with Baird. .

Yes. I just wanted to explore the gross margin for a minute here, the adjusted gross margin by segment here. Both segments were down 300 to 400 basis points. Maybe a little bit surprised around AIT segment being down. So my question maybe is two-fold. .

I mean, first of all, around the freight expenses, we're using the term in a premium freight.

Is the freight expense up structurally, given the realignment around our subcontract manufacturing base? Or is that specifically to the urgency around some of these e-commerce large orders and getting to here? What does that impact?.

Yes, Rich, so I'll take this. I want to start by -- I think our teams have been executing well on what we can control around gross margin. And if you look at the drivers, it's pretty consistent across both of our segments both from an unfavorable business mix as well as the premium freight costs.

And if you look at the -- one of the 3 points, and again, spread between both segments from both large deal mix as well as unfavorable business mix. And just an example, in Q3, the mix of large deals was actually greater than what we saw in Q2.

Another example, which speaks to the AIT point, if you look at our printer business, it has a larger proportion within run rate and exposure to the manufacturing vertical, along with generally higher gross margin. And then another point on premium freight costs.

And to answer your question, really, it's from capacity constraints not so much from the change in our manufacturing footprint. And we're seeing our cost per kilo up 2 to 3x from what we saw pre pandemic, so again, just as some of the capacities come offline with reduction in air travel internationally. .

And I think what's important, if you look at the underlying gross margin trends, excluding the mix dynamics, they do remain healthy. And as the economy recovers and our run rate business improves, so will gross margin, which you'll begin to see here in Q4. .

And AIT has the same, again, large order impact on AIT on the printer side of the business as it does on the MC and scanning?.

What I'd say it's less reliant on large deals, but it has a higher proportion within the run rate -- a higher proportion of run rate business. .

Okay.

And when you look at -- let's move out when things normalize here around the mix of business between the channel and large orders and then this -- kind of this freight, this premium freight starts to dissipate, are we still kind of at this normalized gross margin level for Zebra, that's, let's call it, 47% with modest upside? Is that still a normalized gross margin here?.

Yes. So as we get past the pandemic, we do expect to get back to pre pandemic levels for both EBITDA rate and gross margin rate. And like I said, the like-for-like margins remain healthy. We also would expect the vast majority of our OpEx to return as the environment normalizes.

We have, I'd say, some bit of that will be permanent savings that we'll look to reinvest around the OpEx side. But again, we do get -- we do expect to get back to the pre-pandemic levels, both in EBITDA and gross margin rate. .

Maybe just to add one thing to that. We continue to also develop our portfolio. So as you think of our -- the software solutions we talked about here earlier, they tend to come with a higher gross margin certainly, and scale, we would expect them to have a very attractive EBITDA margin, too. .

Understood. Yes. And then just my second follow-up question, just around the sales and sales channel. Just a quick question.

When we look at the fourth quarter revenue guide of plus 3 to plus 9, is the assumption in there that the channel, both North America as well as Europe, is up year-over-year? Is that assumption in your guide -- revenue guide for the fourth quarter?.

So your question was if the channel is expected to be up year-over-year? Yes. .

So channel and run rate. I'm sorry. .

As in run rate, yes. Okay. So yes. So I'll start here again, and I'll have Joe provide some extra color again. But first, we're quite pleased to be able to guide for both top and bottom line growth year-over-year in Q4 here, but the 3% -- 3% to 7% expectation in growth, and that includes 150 basis points of positive impact from Reflexis. .

First, the large deal activity remains very strong, but the underlying business is recovering faster than we expected, and we are also benefiting from some pent-up demand in Q4. As we entered Q4, though, we also had a strong backlog that helped us in this area.

The higher large order mix that we've seen compared to prior year will continue but not the same degree as in Q3. So we do expect the run rate and the channel business to continue to sequentially grow.

And Joe, any more color for you?.

I don't think I have anything to add. You said it. .

Our next question comes from Brian Drab with William Blair. .

At this point, I guess 2 quick follow-up questions to the recent questions that you were just addressing. So I appreciate that gross margin should get back to the pre-pandemic level. I'm wondering if you could put a finer point on that.

Is that something that we could expect in 2021? Or does the large postal service order maybe weigh on that somewhat in the near term? Is that a longer-term expectation? Or is that a 2021 expectation?.

I think it's a little too early for us to give a detailed 2021 guidance at this stage, but we do expect that our gross margins will continue to sequentially improve, along with the economy and along with the improvement in our run rate business. .

Okay. And then, Anders, you just highlighted also that the software business, of course, should be a tailwind for gross margin as that business grows and which Reflexis, it's obviously a bigger piece of the business.

Can you give us any sense for it? How -- what percentage of revenue now we are at in terms of software? Is it -- can you even say if it's more or less than 5%?.

I know it's not something you've really said in the past, but it's becoming a more meaningful piece, and we don't really know how to model the impact on gross margin without some sense for that. .

Yes. Obviously we're very excited about the software business, and our software and services business has been growing quite nicely. The software business as a whole, I think, is still in the single digits for us, but it's been, as I say, has been growing quite, quite nicely.

And we would expect it to be a much bigger part of our business as we go forward. .

Our next question will come from Keith Housum with Northwest Research. .

And Nathan, congratulations, and welcome to the call. Guys, want to dig in a little bit further into the U.S. postal service. Anders, I think I heard you say that the deal is on a pause until late first quarter, and then we will finish up in 3Q of next year.

So is the plan still to end, I guess, late summer? I'm just trying to get a little bit more idea on the third quarter. And in terms of a pause, are we talking the end of the first quarter, so don't expect much in the first quarter of '21 from the U.S.

Postal Service?.

Yes. First, the pause that we now have is a planned activity from USPS. This was always their intent to not deploy new devices during Canada peak season, and it will start ramping up again in the second half of the first quarter. So the Q1 would be certainly lower than Q2 and Q3, and we expect that late summer, we will be basically wrapping up.

And then we'll continue obviously with other projects and expansions of this project with USPS. .

Great. And then just as my follow-up.

In terms of the Temptime business, can you just perhaps cover, is there an opportunity with that business to take advantage of perhaps COVID-19 vaccine that might be out there on the horizon? And how is that business doing? And how does that go to play here?.

Sorry.

You said Temptime?.

Correct. .

Yes. So Temptime has been doing very well in Q2 and Q3 based on the traditional vaccines that they cover, all the vaccine vials that we cover there.

We are working with WHO and a number of pharmaceutical companies, logistics companies, to ensure that we are well-positioned to provide solutions with respect to a COVID vaccine when that becomes available. .

We have received initial orders from people who are kind of proactively looking to build up the -- an inventory and capabilities for this, but they have been quite small, but we expect that, that can be a nice addition to the business in 2021. .

Our next question will come from Blake Gendron with Wolfe Research. .

I do want to circle back on the deal size evolution here. I know we've been talking about it this morning. But if you were to quantify the year-over-year impact of deal mix in terms of bps or whatever, that would be super helpful. .

And then on a scale of 1 to 10, 10 being pre-pandemic normalized mix versus 1 being sort of the trough where large deals dominated in the second and third quarter, I would imagine, where do you expect the fourth quarter to be just because you do anticipate some of the smaller deal size coming back?.

And then as an offshoot to that on working capital, you offset some of the receivables friction with payables and things like that.

Are the receivables, AR, is that impacted by deal size as well, where we should expect maybe a little bit of friction just given the mix?.

Yes. So to answer your first question around the growth we're seeing in both respect to the large and nonlarge deals. So again, just to clarify, when we say large deals, those are greater than $1 million. In the third quarter, the large deals grew over 35%, and our nonlarge deals were down over 15%.

And that -- hard to put a 1 through 10 classification on it. I would say, as we get into Q4, it is going to be slightly higher large order mix than the prior year, but definitely not to the same degree as Q3, and we'd expect that to continue to maybe go back to pre-pandemic levels as we head into 2021, as we see a gradual recovery in the economy. .

And on your last question around AR factoring. I wouldn't say that we've seen any additional friction relative to deal size. It had a modest impact on our year-to-date cash flow, and we'd expect to see a relatively modest impact on our full year guide. .

Maybe just one more -- add to this and the prior question. So we've had a lot of focus on investors on USPS and the impact of USPS had on our business. And U.S. is obviously a large deal, but it was not what drove our Q3 overachievement. USPS came in very much as per our expectations. .

Understood. I appreciate that additional color. And then a follow-up, if I could, on the regional growth, you broke it out in the slide deck. Looks like North America, Europe, Latin America, kind of trending actually a little bit better than maybe some of your indicators would suggest. .

APAC was down pretty heavily, maybe more so than other companies have disclosed, at least directionally.

So on Asia Pacific, is the issue there, just -- first of all, is it a discrepancy? And then is it due to China versus non-China?.

Is it health of specific end markets or customers? Is there something going on with the channel inventory levels there? I'm just trying to get a better feel for, I guess, the weakness in APAC. .

Well, first, more globally, I'd say what you see globally and also in Asia Pac is some of the secular trends that are supporting our business have accelerated as part of COVID. So around omnichannel, the digitization and automation, those are all -- those are global trends. .

And in Asia Pac, that we have -- our business has been driven more by, say, a run rate business rather than large deals. So the run rate business in manufacturing has been larger parts of our Asia Pac business than in other areas. .

And specifically in Q3, I think the COVID-19 drove bigger declines in Southeast Asia and India, where good parts of those countries were more or less shut down. So that was more impactful for Asia Pac. But Asia Pac was up from -- sequentially from Q2, and China actually returned to growth. .

And as I said, we have new leadership in China, a new General Manager who's doing a great job there for us. We did also see some relative strength in Australia in Q3. .

Our next question comes from Andrew Buscaglia with Berenberg. .

I just wanted to clarify something on the USPS award. So you said you're going to wrap up most of the deal -- or most of that award by end of Q3. I think the deal was -- the award was $570 million in total or upwards of.

I guess, what portion of that will be fully wrapped up? Because I know there's follow-on stuff that is comprised within that $570 million. .

Yes. I think the contract award was up to a maximum of $575 -- $570 million. I don't think at this stage, we can give you -- I won't break out and say specifically how large the volume for the USPS will be as part of this contract. .

Okay. Okay. Also in your Q4 guide, it was a nice guide, and I think about 1/3 of your sales is EMEA, which didn't quite rebound as much as North America, and now we're starting to see lockdowns again.

So I guess what have you contemplated in that guide? Is it conservative? And does it take into account, kind of what's going on in Europe?.

So we feel confident in our sales guide for Q4. It reflects the positive momentum we have in the business. We entered the quarter with a strong backlog. We had very healthy levels or lower levels of inventory in the channel. So the quarter is actually more front-end loaded than normal. So we do see that has -- as giving us great confidence in our guide. .

But there's obviously still continued pressures from COVID and some uncertainty around this.

I'd say, though, with -- specifically to Europe and some of the lockdowns there that I think if you compare this to April when -- or end of March when the lockdown started, I think now companies -- most of the first -- most of the lockdowns are intended to be more on the aspect of the social life rather than enterprises and business life. .

And I think companies like ourselves we have learned, I think, how to operate much better in this environment.

So I would expect that the impact of a lockdown would be less severe now, and the lockdown would, again, I think, drive some of the trends that we've talked about around omnichannel and buy online, pick up in-store and so forth, which would have some offsetting positive impact for us. .

Our last question today will come from Jeff Kessler with Imperial Capital. .

What -- when you talk about providing a full, let's call it, recurring revenue SaaS-type of solution that you're developing going forward, which vertical markets have been -- which vertical markets do you think have been most interested in at least talking about how to get to a, if you want to call it, a full Zebra solution for them at this point?.

I'm not sure if I can say that any vertical has more -- been more excited about this than others. Maybe I can say, though, that our -- if you look at some of our more recent software acquisitions like Reflexis and Zebra Prescriptive Analytics or Profitect, as it was previously known, the primary vertical markets that they address have been retail.

So we're probably further along in retail than we are in other markets. But I say I would highlight health care is certainly an industry or a vertical that has a lot of interest in broader solutions and acquiring them as a service. .

Okay.

And a follow-up, in terms of what types of services and/or technologies might be add-on to USPS, once you've done the first part of the contract? Would that be instructive for other -- for other areas in which you might be able to expand your total available market?.

Yes. I'm not sure if I want to get ahead of ourselves and talk about what possible business we might win from USPS in the future. USPS is a customer of many of our products already, so printing, scanning and mobile computing services, some software solutions.

So I see opportunities for us to engage across a broad suite of solutions, but I don't know that I want to highlight any specific ones for you. .

Okay.

And just quickly, in that line of thinking on new types of technology, with regard to your mobile scanners and with the other technologies that you're employing, have you been taking a look at the increase in other types of identifiers, such as BLE or NFC? Other types of technologies that may be complementary to what you're using right now?.

So I guess the broad answer will be yes. We're certainly looking at all sorts of data capture type of technologies. And our mobile computers, many of them have NFC already. So we're always looking to see how we can provide the right type of functionality to enable our customers to get the best ROI for those solutions. .

Yes. You might -- this is Joe Heel. You might remember that we introduced the proximity monitoring solution. That's based on Bluetooth low energy, which is built into our devices. And NFC technologies, for example, are used in solutions we have for railway ticketing.

So those are all technologies we're already using, and we think have more potential in the future. .

This will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks. .

Yes. To wrap up, I would just like to thank our employees, customers and partners who are working in the frontline during this challenging time. Our team is executing well through the pandemic, and we are proud that our technology solutions are helping enterprises navigating through the challenges of COVID-19 as the world recovers. Stay safe, everyone.

.

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