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Edited Transcript of ZBRA earnings conference call or presentation 30-Apr-19 12:30pm GMT

Q1 2019 Zebra Technologies Corp Earnings Call

LINCOLNSHIRE May 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Zebra Technologies Corp earnings conference call or presentation Tuesday, April 30, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anders Gustafsson

Zebra Technologies Corporation - CEO & Director

* Joachim Heel

Zebra Technologies Corporation - SVP of Global Sales

* Michael A. Steele

Zebra Technologies Corporation - VP of IR

* Olivier C. Leonetti

Zebra Technologies Corporation - CFO

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Conference Call Participants

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* Andrew Edouard Buscaglia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Brian Paul Drab

William Blair & Company L.L.C., Research Division - Partner & Analyst

* Erik Taylor Lapinski

Morgan Stanley, Research Division - Research Associate

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Jason Andrew Rodgers

Great Lakes Review - VP

* Jeffrey Ted Kessler

Imperial Capital, LLC, Research Division - MD

* Keith Michael Housum

Northcoast Research Partners, LLC - MD & Equity Research Analyst

* Richard Charles Eastman

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Q1 2019 Zebra Technologies Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead, sir.

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Michael A. Steele, Zebra Technologies Corporation - VP of IR [2]

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Good morning. 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 the slide presentation.

This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Olivier Leonetti, our Chief Financial Officer. Anders will start with our first quarter highlights. Olivier will then provide more detail on the financials and discuss our second quarter and full year outlook. Anders will conclude with progress made on Zebra's strategic priorities. 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 Xplore Technologies and Temptime businesses. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year.

Now I'll turn the call over to Anders.

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [3]

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Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team executed well and drove solid profitable growth in the first quarter. As you can see on Slide 4, we reported net sales growth of 9% or 8% on an organic basis; an adjusted EBITDA margin of 21.1%, a 20 basis point year-over-year improvement; non-GAAP diluted EPS of $2.92, a 14% increase from the prior year; and free cash flow of $27 million. We achieved strong performance across Asia Pacific, EMEA and North America. Our team drove growth across the vertical markets we serve and demand remained strong through the channel. Our data capture and mobile computing product categories performed especially well. We also scaled operating expenses while at the same time investing in our employees and initiatives to drive sustainable growth.

Additionally, in the first quarter, we closed on the acquisition of Temptime Corporation, a leader in time-temperature monitoring, which is an attractive growth opportunity for us.

Our solid start to the year and leading portfolio of solutions provides us confidence in our outlook for 2019.

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

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [4]

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Thank you, Anders. Let us start with the P&L. As you can see on Slide 6, net sales grew 9.1% in the first quarter, which translated to 7.9% on an organic basis before the impacts of currencies and acquisitions. We saw growth in each of our reporting segments and across most geographies. Enterprise Visibility & Mobility segment sales increased 11.6%, led by especially strong demand in data capture and mobile computing products.

Asset Intelligence and Tracking segment sales increased 1.2%. We realized strong run rate business, which was partially offset by fewer large printer orders in North America than the prior year.

Turning to our regions. In North America, sales grew 7% driven by double-digit growth in our mobile computing and data capture categories. We saw particular strength in health care and retail. Sales to small and midsized accounts remained strong.

The EMEA sales increased 9%, with relative strength across data capture, printing and mobile computing. We saw broad-based growth across the continent. Retail was particularly strong with continued traction in RFID.

Sales in our Asia Pacific region were up 12% with strength across all major product and service categories. Most countries grew double digits, including China.

Latin America sales decreased 3%, primarily due to lower sales in Mexico due to geopolitical weakness. Adjusted gross profit increased $37 million or 8%.

As expected, adjusted gross margin decreased 50 basis points from a strong margin rate in the prior year period, primarily driven by less favorable business mix in both operating segments. We expect favorable year-over-year margins in Q2 and the full year as I will cover in my outlook commentary.

Consistent with one of our principles, adjusted operating expenses as a percentage of net sales decreased 100 basis points from the prior year period. We achieved this operating leverage while continuing to make meaningful investments to drive organic growth.

First quarter 2019 adjusted EBITDA margin was 21.1%, a 20 basis point increase from the prior year period.

We drove non-GAAP earnings per diluted share of $2.92, a 14% year-over-year increase.

Turning now to the balance sheet and cash flow highlights on Slide 7. In the first quarter of 2019, we generated $27 million of free cash flow. This was $71 million lower than the prior year, reflecting increased working capital usage, including higher incentive compensation payouts tied to exceptional 2018 performance. Additionally, as expected, the timing of certain working capital items that benefited the fourth quarter of 2018 had an unfavorable impact on Q1 2019 cash flow. Keep in mind that we are committed to a target of 100% free cash flow conversion, which fluctuates by period due to various short-term factors such as those I just covered.

We had net borrowings of $146 million in the first quarter, which were primarily used to fund the acquisition of Temptime. We ended the first quarter with $1.7 billion of debt on the balance sheet. As of the first quarter, we had 1.9x net debt-to-adjusted EBITDA ratio, which is within our targeted range of 1.5 to 2.5x.

Let us turn to our outlook on Slide 8. We expect Q2 2019 net sales growth to be between 7% and 9%, which assumes an approximately 2.5 to 3.5 percentage points positive impact from recent acquisitions and an approximately 50 basis point negative impact from foreign currency changes.

We believe Q2 2019 adjusted EBITDA margin will be in the range of 20% to 21%, which assumes a high gross margin both sequentially and from the prior year.

Non-GAAP diluted EPS is expected to be in the range of $2.80 to $2.95.

We are raising full year 2019 net sales growth to be between 5% and 8%, which assumes an approximately 2 percentage point positive impact from recent acquisitions and approximately 50 basis point negative impact from foreign currency changes. Full year 2019 adjusted EBITDA margin is now expected to be between 21% and 22%, an improvement from 2018 and our prior guide. We continue to drive operating leverage and gross margin improvement in the business.

We expect that full year 2019 free cash flow will exceed $625 million. We continue to expect to drive higher EBITDA, and unlike 2018, we are assuming that working capital will be a use of cash in 2019.

You can see other full year 2019 modeling assumptions on Slide 8.

With that, I will turn the call back to Anders to discuss progress on our strategic priorities.

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [5]

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Thank you, Olivier. We are very pleased with the progress we made in Q1 and the momentum in our business. Slide 10 shows our key strategic areas of focus, which support our industry leadership and drive value for all stakeholders.

First, we continue to outpace the competition through our innovation, unmatched scale and strong relationships with customers and partners. Our mobile computer, data capture and printing portfolios have never been stronger. This has been accomplished through focused R&D investment to build upon our best-in-class offerings. We continue to see meaningful opportunities to address targeted underpenetrated geographies and market segments in our core business. We are capitalizing on key technology trends, including cloud-based printing, RFID and the transition in data capture to 2D imaging.

Another trend has been the migration to the Android operating system, which now represents more than half of enterprise mobile computing sales in the industry. Many large retailers have made the transition, but we are early in the adoption curve in the warehouse environment.

Second, we are focused on driving growth in attractive markets where we can leverage our competitive advantages. We plan to scale existing categories where we are underpenetrated and enter new markets outside the core that advance us as a solutions provider. We expect to gain traction in these markets through both organic and inorganic investments. We target high-growth near adjacencies where we have a right to play, seeking businesses that can transform flows with our solutions. An organic example is in RFID where we have been launching new fixed and mobile products and solutions that provide our customers significantly higher tracking accuracy for various use cases.

From an inorganic growth perspective, we gained traction in smart supplies with the acquisition of Temptime Corporation. Temptime is the leader in designing and manufacturing a time-temperature monitoring portfolio that meets the strict specifications of the largest global health organizations' vaccination programs. Our business is to scale this technology deeper into the health care industry as well as drive it into other use cases that can benefit from increased asset visibility.

Third, we are advancing our Enterprise Asset Intelligence division to enable every front line asset and a worker to be visible, connected and optimally utilized. We are doing this by leveraging our deep knowledge of workflows and capitalizing on key megatrends. I will discuss this more in a minute.

Lastly, maintaining our financial flexibility remains a key priority as we invest in the business to accelerate our traction in attractive markets.

Now turning to Slide 11. Zebra enables our Enterprise Asset Intelligence vision by providing a digital view of the entire enterprise. Our products and solutions send data from assets, products and processes. This information, including status and location, is analyzed in real time to determine the best possible operational action to improve productivity and give greater insight into business operations. Our purpose-built products include a software layer, which makes them easy to integrate and intuitive to manage. Additionally, our new software applications and tools improve automated data collection and analysis, maximize device security and enhance ease-of-use.

Another integral part of our solutions ecosystem is Savanna, our cloud-based platform that powers our intelligent edge solutions with real-time data. Savanna is a key enabler of a wide range of our data-rich offerings. A newer example is our Workforce Connect software application, which enables our customers to marry all of their communications onto a single mobile computer. Our team is encouraged by the additional opportunities we see to leverage the valuable data that is accessed through Savanna. We have been collaborating with an increasing number of our independent software partners to utilize this platform to deploy new solutions that address our customers' challenges.

The rise of machine vision, analytics and artificial intelligence is driving a new wave of intelligent automation, which is complementary to our core business and a natural extension of our vision. Unlike repetitive automation, intelligent automation leverages our sense, analyze, act framework to improve workflow efficiency with or without a human operator. A key example is our recent venture investment in a company that specializes in the collaboration of humans and robots to fulfill orders on the warehouse floor.

We have made strong progress on our Enterprise Asset Intelligence division as we helped businesses across many industries digitize their operations and gain a performance edge. Zebra is benefiting from key technology megatrends, including mobility, automation, cloud computing and the proliferation of smart devices and sensors, each of which are critical components to this transformation.

Slide 12 highlights our primary vertical markets: health care, retail and e-commerce, transportation and logistics and manufacturing. In health care, our fastest growing vertical, we are tracking clinical equipment and enabling caregivers to monitor patients while being mobile. These solutions translate into increased patient safety and reduce costs. We recently signed a new record health care deal for Zebra with one of the largest health systems in Canada. This customer is initially deploying premium handheld imagers and a range of desktop and mobile printers to manage specimen handling, wristband identification and other use cases. This Zebra solution increases productivity and improves the overall level of patient care for this customer.

In retail and e-commerce, we are a trusted strategic partner for many of the largest companies in the world. We support their goals to drive their productivity metrics and improve customer satisfaction. An increasing number of our customers are equipping their associates and shoppers with our mobile computers that empower them with their real-time information they need to successfully execute omnichannel fulfillment and elevate the overall in-store experience.

Additionally, it is common for our customers to deploy a wider range of our solutions for their various use cases. Examples include our mobile computers and printers, flatbed and handheld 2D scanners as well as RFID solutions.

At the ProMat trade show earlier this month, we showcased innovative solutions that help our manufacturing and transportation and logistics customers digitize their supply chain and modernize their warehouses. These include the next generation of Android mobile computers, RFID products and solutions to provide a digital view of their trailer loading process and worksite activities.

According to our research, our customers are faced with daunting scale challenges driven by the on-demand economy. To do this increased volume, more than half of warehouse leaders plan to either add warehouses to their operations or enlarge current facilities over the next 5 years. By helping to drive increased productivity and efficiencies, we can help limit the scope of these costly expansions.

At the ProMat showcase, Purolator, a leading Canadian freight, package and logistics solutions company, demonstrated how they are using software on Zebra's mobile computers for track and trace, dispatch and hub management operations. Together with a trusted partner, we have implemented a 5-year as-a-service deployment model for Purolator. This solution will improve delivery time, increase worker productivity and enhance customer service.

In manufacturing, our customers are looking for trusted partners who can increase their operational visibility while reducing cost and complexity. A notable example can be found with a major Latin American food manufacturer. The project includes plant floor solutions using our ET50 tablets and ZT400 series industrial printers across all their facilities in the region. It was a consultative engagement, which was initiated by our experts assessing this customer's operations and prioritizing optimal solutions.

We were recently awarded a sizable data capture deployment with a customer outside of our traditional verticals. A large Italian gaming company recently rolled out our products to comply with the European Union anti-money laundering directive. They need to efficiently capture certified identification data from their customers for lottery ticket purchases, and our solution best met very unique needs. We are pursuing additional opportunities with other prospective customers who need to comply with this regulation and similar directives.

In summary, we are excited about the innovative solutions we are implementing with a diverse set of enterprise customers worldwide. Secular trends, including the on-demand economy, and increased regulation are driving increasingly complex business priorities that Zebra is uniquely positioned to address.

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

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Michael A. Steele, Zebra Technologies Corporation - VP of IR [6]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And today's first question comes from Jim Ricchiuti of Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Two questions. First, I wanted to focus more near term on the environment for mobile computing. You're continuing to see good strength in that market and we've talked about the upgrade opportunity. But it appears that it's much more than that, that this is not just an upgrade opportunity but it's also a market expansion story tied to associates using more of these. Is there any help you can give us in terms of how we might think about the growth rate for this portion of the business over the next year or so?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [3]

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Yes. Thank you. First, all our product lines grew this past quarter. They were fueled by the innovative and broad portfolio of products and solutions that we have. And I think also our deep understanding of our customers' vertical workflows and how we can leverage data at the edge is great enablers of new use cases and a way for our customers to derive data -- or derive value out of our solutions. So we're very excited about the opportunity we have across all our product lines, and we're enabling several megatrends such as the on-demand economy with this.

And specifically to our mobile computing portfolio, we had broad-based growth in Q2 and we've had great momentum in the business for several quarters now. I think I'd highlight 2 key drivers that we see: one is new use cases and the other one is in the Android conversion across the industry. First then on the new use cases, I see that as a good long-term driver for the business. Three specific subpoints, I guess, here.

First, we are seeing a lot of our customers consolidate multiple devices or applications onto a mobile computer. So if you think historically, they would have a printer, a scanner -- or not printer, but scanners and walkie-talkies, desk phones or PBX extensions. All of those things can now be consolidated onto our mobile computers, and the Workforce Connect will be a great example of a software application that we developed that helps do this. And that makes the ROI very strong for purchases of mobile computers.

Second trend will be around our customers are looking to have -- put a device in the hand of every worker so that they're reaching much further into their operations to deploy technology and obviously that's a great driver for us.

And third, and I talk about screen size, so our tablet business. The tablet side of business, the bigger screen sizes, are growing as a market faster than the traditional mobile computers. And we're seeing more site managers getting tablets to digest the data that's being ingested by our mobile computers. So those are our 3 kind of new use cases that we see driving growth.

And then on the Android transition, that continues to be a good catalyst for us. Now more than 50% of the market is Android and so less than 50% of new devices sold are Microsoft. There are still substantial amount of Microsoft devices going into the market. And we have approximately 60% market share of the Android space and approaching 50% overall. So it's still a huge potential here with approximately $10 million legacy Windows devices in the market that over time will need to be converted.

And maybe Joe Heel, you want to add a little bit to this?

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [4]

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Yes. The Android transition has been a terrific opportunity for us and we do see that continuing in the space that Anders described with about 10 million devices left. Where are those devices? Well, you see that we've -- the core retailers have adopted our solution quite broadly. And now we're seeing the expansion in T&L, in manufacturing. The warehouse is really the frontier that we're working on right now as well as mid-tier accounts, right, where the larger accounts have adopted, now the mid-tier is adopting.

And one of the things we're seeing that you can also see in the market is that before a customer can adopt, their software application has to be available on Android. And so we've been working hard with ISVs who have come to our program in very significant numbers to help them move their applications to Android, and that's I think the indication that the expansion into the warehouse and the manufacturing space is where the Android migration will go next and the rest of those 10 million computers will be what we will pursue.

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [5]

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Yes. So you can see there are many reasons for us to be excited about the mobile computing portfolio.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [6]

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That's helpful, Anders. I have one other question, if I may. As you look at the business and look back over the last 1 to 2 years, are you surprised at all by the increased pace of change with respect to how retailers and some of the logistics operators are moving to adopt automation technology? Are we seeing something that appears to be more of an acceleration versus where you might have thought the market was going to be a year ago?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [7]

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I'd say the -- we're not particularly surprised. I think we've expected this and worked for this for a long time. I often kind of joke and say, tell people that overnight successes took years to happen, and so we've been working on a number of these initiatives and new solutions to enable these changes and this higher pace of change. So we've been at this for a long time, but it may not necessarily become apparent to outsiders how long we've been working at it. It comes across as being maybe we're an overnight success.

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [8]

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I mean as one point of evidence, almost 5 years ago, we put forward division of Enterprise Asset Intelligence, right, which is sense, analyze and act. And the automation is a natural part of that and we're just seeing increasing opportunities to bring together all these technologies that we've had in the past and the innovations that we'll bring to market in the future to capitalize on that automation trend.

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Operator [9]

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And our next question today comes from Jason Rodgers of Great Lakes Review.

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Jason Andrew Rodgers, Great Lakes Review - VP [10]

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I wonder if you could talk a little bit more about the unfavorable business mix that you saw in both segments in the quarter and perhaps mention some of the factors that give you confidence that mix will improve in the second quarter?

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [11]

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I believe you are referring to the margin trend, is that correct, Jason?

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Jason Andrew Rodgers, Great Lakes Review - VP [12]

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Correct.

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [13]

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Yes. So in the quarter, and that was part of our Q1 guide, we had a gross margin rate being lower than Q1 last year. If you remember, Q1 last year was a strong margin rate. What expected -- what happened in Q1, as expected, was 2 things: one, the Zebra Retail Solution, which is a very -- which is a high-margin business, was very focused in Q1 last year. This year, this revenue will be spread. The impact on the quarter is about 20 basis points. And then you add some business mix impacting also the margin.

Now implied in our guide is that we expect Q2 margin to be higher than Q1 of '19 and we expect the rest of the year margin to be higher than last year. And if you look at our P&L over the last 2 years, you have seen that we've been able to scale margin up. We believe that this year would be no exception and we feel comfortable about the levers we have to achieve that goal.

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Jason Andrew Rodgers, Great Lakes Review - VP [14]

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And then as far as the leverage that you have, I believe perhaps last quarter you talked about the net debt-to-EBITDA approaching the bottom of your range around 1.5x by midyear. Do you have an update on that target?

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [15]

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Absolutely. So in the -- at the end of Q1, our leverage ratio was 1.9x. We have a target. We have said that during our last call, target leverage of 1.5 to 2.5. We believe, and you can sense that from the remarks from Anders and Joe, we are very excited by our end markets and by our ability to compete. As a result, in terms of capital allocation, the priority would be to invest in our business either organically or through M&As. We believe that, that would provide us with the best adjusted return. Now share repurchase will become a consideration if we stay below our targeted leverage on a sustainable basis.

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Operator [16]

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And our next question today comes from James Faucette of Morgan Stanley.

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Erik Taylor Lapinski, Morgan Stanley, Research Division - Research Associate [17]

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This is Erik on for James. I just wanted to ask like as you're thinking through the current demand environment, have you seen any softening of RFPs or cancellations or pushouts?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [18]

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We have not seen any pushouts or any particular softening. The year has progressed very much the way we had expected. So if you go back to 2018, we had a very, very strong growth rate and the annual guidance we've given here is for that to moderate, but I think that has been entirely expected by us and projected. So far, I would say the year is progressing pretty much the way we expected it to.

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Erik Taylor Lapinski, Morgan Stanley, Research Division - Research Associate [19]

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That's helpful. And just thinking through that, if you're -- are there any areas where maybe your models have ticked down or may have ticked up or still pretty much where you're expecting?

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [20]

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Pretty much as expected at this stage in terms of top line and profitability. And when you look at the quarter also, and that has been a theme, you see that we have a very diversified business either by region, by product, by vertical. So we think -- we are feeling good about where we are as a company and we are serving important secular trends. So we are feeling good about where we are as a business.

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Operator [21]

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And our next question today comes from Richard Eastman of Robert W. Baird.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [22]

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Just a question around the AIT, the printing business. Could you just speak maybe a little bit to the core growth in the quarter? You still have some tough comps in Q2, Q3. Just curious how you expect that business to play out through the balance of the year. And also it's interesting, I presume you've got some price there, but the gross margin was quite good relative to what we were thinking. So maybe just kind of address the pricing and the growth rate in printing, if you would.

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [23]

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First, AIT had a good performance in the quarter. We grew on the back of strong supplies performance, and within supplies, we had a relative strength within wristband and RFID.

The overall printer market had fewer large deals, large orders in Q1, which also we saw less large deals than we did a year ago. But that was offset by particularly strong run rate business for us.

But looking a bit more longer term, we have a very strong and fresh portfolio of smart connected printers with really unrivaled manageability through our Link-OS operating system. That's a great differentiator for us. We've launched a number of new printer products over the last 12 to 18 months, which are being very well accepted by the market and helping to ramp. So we are excited about our printing portfolio and the growth prospects we see in the market.

Specific to pricing, I'll see if Joe had any comments on that.

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [24]

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Well, I give you 2 pointers that are perhaps more a mix point, which is, on the one hand, the higher end of our product range, the tabletop printing range, had a strong quarter. If you look carefully in the regional piece, you'll see that Asia Pacific did well where a lot of the regional printing business in the high end is concentrated.

And another area where mix improvement has helped us is in the supplies business. We've always said that supplies is a growth opportunity and we've focused recently on making the mix move towards the more profitable parts of that portfolio.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [25]

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And just as a thought there. Was there anything in the channel, was there any inventory adjustments in the channel moving from the fourth quarter into the first quarter? Any pull into the fourth quarter based on pricing or programs or anything like that?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [26]

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No, we didn't see any pull-ins into Q4 particularly and there was nothing out of the norm that was going over that channel. The channel inventory is within the normal range of days in the inventory as we set out with them and the channel performed very well, though, for us, a strong run rate. So it was all good.

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Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

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Okay. And then just as a follow-up, Anders. Could you maybe talk just generally about Xplore now that you have that acquisition integrated? What does the product road map look like there? Is there an OS upgrade opportunity there? You mentioned larger screens maybe being a factor in mobile computing. But just any thoughts you can have around Xplore Technologies and maybe what their product road map looks like as you move forward to stimulate growth there?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [28]

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Yes. I'll start and then I'll ask Joe to provide some extra color also. But overall, our big screen or tablet portfolio is performing very well, that includes then the Xplore Technologies portfolio but also ET50 tablets that we had before. And with the Xplore acquisition, we've become the clear #2 in the tablet space. So quite excited about the opportunities we see there.

We have already launched a number of new products for Xplore, which have been well received, and we are looking to here to soon launch our Android products for Xplore. So we're looking to basically extend the traditionally Android portfolio of mobile computers into the tablet portfolio also, and we've had already the ET50 on Android for some time.

We've also now fully integrated organizationally the Xplore into Zebra and all the IT stuff will be done here this quarter. Xplore is now part of our PartnersConnect partner program. So every reseller around the world has the ability to sell our full tablet portfolio and all our sellers are incorporating that also.

So overall, I think we feel very good about what's going on with our tablet portfolio and the growth prospects we have. Joe, any further thoughts?

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [29]

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I'll add one other thing that we're particularly excited about, which is, as Anders mentioned, the flagship product of the Xplore line that we just launched is the L10. We launched it on Windows, and coming up towards the middle of the year is the Android launch of that same product line.

That's significant because one of the big drivers, as we talked about earlier, of our growth in Android has been our ability to bring our platform, our Android platform and Mobility DNA and all that differentiating capability we have into the market. And now we're bringing that to the market in ultra-rugged tablets. There's nothing like that in the market today.

And what it provides customers is now a complete portfolio from the refreshed, so this is the other great change that's coming, the refreshed ET50, so there'll be the ET51 and 56 as a semi-rugged Android tablet complemented with now the Xplore rugged tablets, also on our Android platform. There's nothing like that in the industry. So we're very excited about that as being a major expansion for the Xplore portfolio.

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Operator [30]

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And our next question today comes from Brian Drab of William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [31]

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The first question is just on the guidance and what it implies for the second half of the year. I just want to make sure that I'm understanding this correctly. So the guidance for 5% to 8% revenue growth for the year, if you hit the midpoint in the second quarter, the growth in the first half will be about 8.5% and the guidance implies then about 4.5% in the second half including a net tailwind from FX and acquisitions.

Can you just talk about how, number one, the outlook for larger orders appears to be developing for the second half of the year? And number two, what you're expecting for relative growth between EVM and AIT for the second half of the year?

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [32]

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So your calculation is correct. We feel confident about the numbers you have mentioned based upon the visibility we have, and that despite strong comps. And the reasons for this confidence, I'm not going to spend too much time on this, is based upon the strong secular trends we are today serving.

In term of large orders, we are not planning for large orders at this stage to be a significant part of our business. And in terms of growth profile between the various businesses, we think mobile computing still being strong. We believe that data capture would be, as well, stronger performance. But as we indicated before, printing supplies and also services and software are going to contribute to the growth and offer us various avenues to keep growing the company and post good profitability profile.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [33]

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Can I just clarify, do you think in the second half of the year that EVM continues to grow at a faster rate than AIT as we saw in this first quarter?

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [34]

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That's the planning assumption today, indeed. And we covered the drivers behind that earlier, Android and new use cases.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [35]

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Perfect. And then it's been a couple of quarters since you've commented on the potential positive impact of a rollout -- or more extensive rollout of 5G capability across the infrastructure. Can you talk about what impact 5G could have on your business and the timing of that impact potentially?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [36]

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First, 3G services are expected to be turned down by 2021. So that would be one driver towards -- upgrading towards the 4G or 5G devices. 5G rollout, we haven't announced when we will have -- launch our first 5G device. But I would say, we are not highlighting us much because we don't see it as a real near term or certainly a 2019 opportunity. But longer term, 5G can have a great impact on our business. It can really make the -- drive further connectivity at the edge of the network. You can have a lot of different types of devices connected and leverage data, including mobile computers or printers and even scanners. So if you think of small warehouses or retail stores that might decide to not implement WiFi going forward, they might just go for a 5G as the connectivity for the store and have all the applications in the cloud instead. So I think there's many drivers that can be very helpful to our business based on 5G.

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Operator [37]

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And our next question today comes from Keith Housum of Northcoast Research.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [38]

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I was hoping for a little bit more color on the Xplore acquisition. I understand the commentary that you guys provided here. But if I look at the numbers that is provided here both in the fourth quarter and this quarter, it appears that Xplore has actually been slowing down from when you guys bought it. Were there challenges that were existing in the business or has some of the business moved over to the Zebra tablets that suggests that it's underperforming now and you guys will expect it to accelerate here from -- from here on in. But hoping for some color for that?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [39]

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Yes. So I'll start and then Joe will provide some extra color. But first, I'd say Xplore is performing in line with our expectations from when we made the acquisition. So we are quite pleased with the performance overall. It's meeting our expectations. One thing to remember, beginning of 2018, Xplore had some very large refreshes that kind of made those quarters look stronger than, say, an average trend line would be. And we hadn't expected that some of those large refreshes to repeat this year, but those are still customers and we're still supporting them but not for the same volumes. Joe?

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [40]

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Right. So Keith, perhaps the way to look at it is if you take those large refreshes from the prior year, in our plan, we had not expected that those would repeat this year. So our target, and that's why Anders said it's performing according to our plan, is to grow quarter-on-quarter without those large refreshes. And if you look at that, that's exactly what you see. So we're quite pleased with how that's developing.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [41]

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Got it. Appreciate it. And then, Anders, do you have a little more color on I guess one of the earlier questions where we're talking about EBITDA margin guidance going throughout the year as well as gross margins. I believe you referenced that you had some leverage to pull to expand gross margin as the year progresses. Can you provide a few examples what some of those gross margin opportunities would be?

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [42]

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So let me cover that, Keith. So we believe that we have the ability to improve margin and scale OpEx, and actually this is an operating principle for the company. We have demonstrated that over the last 2 years and we are demonstrating that in our guide also this year.

To answer to your question specifically on margin, we are using a series of levers. First of all, COGS levers, how do we optimize our supply chain. So design for value, adding more and more combined parts between the various devices. And also we're optimizing the way we price and the way we price to value. And having software, hardware packaged together allows us to sell on an ROI basis rather than just -- not only on price.

And on OpEx, just to finish my discussion here. We believe that as we are growing the business, we are able to add dollars in OpEx, but nevertheless, scale. And you saw in the quarter, Keith, we scaled OpEx as a proportion of revenue by about 100 basis points and we do the same this year as we did over the last 2 years.

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Operator [43]

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And our next question today comes from Andrew Buscaglia of Berenberg.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [44]

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Just a question on -- so one of your larger competitors saw some destocking with their distributors in the quarter. Sounds like you guys never really see that. Can you talk a little bit about that, and if you looked into that, where you saw any impacts related to that?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [45]

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Yes. We can't comment really on what our competitors have said or what's been going on with their business. But from a Zebra perspective, we did not see any destocking in the channel in Q1. We managed our days on hand inventory ratios with our distribution partners, which is just the ones who hold inventory. The resellers don't hold inventory regularly. We always manage the days on hand ratios very carefully. So we want them to have adequate stock to be able to support the market, but we don't want them to have a more and be, I'd say, heavy as that impacts their profitability targets and how much they can invest in other programs to help us drive demand. And our sales team is incented on sales out, so there's no particular incentive for them to drive sales in if it doesn't have a clear path to get sold out. So for us, the channel performed very well. We had strong sales out data and we saw no signs of destocking.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [46]

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Okay. And your cash flow in the quarter, was that in line with your expectations? I mean, it was a little lower than I was expecting and you're going to have a little bit of a ramp to catch up to your guidance, looks like.

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Olivier C. Leonetti, Zebra Technologies Corporation - CFO [47]

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You're right. We are still, as again, another principle, we are managing cash to ensure that we have a free cash flow conversion of about 100%. We might not need that ratio in every single period. And in Q1, that was one of those. That was expected.

Two reasons for this. We had a strong cash conversion cycle at the end of Q4, if you remember, Andrew, and that's an impact in Q1. And also we had high incentive compensation payments in Q1 as we paid our bonuses due to the exceptional performance in '18. But we are driving this business to drive about 100% free cash flow conversion, and we have, to your point, some catch-up to do but we believe we have the plan to do this. So we are confident about the cash flow numbers we communicated to you, Andrew.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [48]

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Okay. And maybe one last one, if I may. I mean, this Temptime acquisition, I think, is pretty interesting. You guys going a little bit deeper in health care, medical. Is this sort of a tip to what you'll -- where you want to continue to invest? Or is it more so we just think of this as a one-off that it came up at the right price and you took it.

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [49]

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Well, Temptime is, we felt, was a great acquisition for us. It really helps us in 2 areas: one, we've talked about supplies as a near adjacency where we are not as penetrated. We don't have the market share that we think we should have. And the other one was around the connecting the digital and -- the physical with the digital, so kind of the EAI aspect of the supplies here. So Temptime could address both of those. We thought that was very attractive and exciting for us. I'm not sure how many specific opportunities we'll have to do that again, but we -- so I'm not sure I will say this is a trend, that we'll see more of those. But we like the supplies business and we clearly like the EAI aspect of this of how to digitize our supplies business.

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Operator [50]

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And our next question today comes from Jeffrey Kessler of Imperial Capital.

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Jeffrey Ted Kessler, Imperial Capital, LLC, Research Division - MD [51]

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I was interested in your comment about the Latin American food manufacturer that the way you want it was on a consultative engagement. Are you seeing a better mix of, if you want to call it, gaining a contract at the C level relative to going in and just dealing with the facilities people or the security people, et cetera, et cetera. Are there going to be more of these types of, if you want to call it, longer-term trust-oriented value proposition negotiations that you can identify for specific vertical markets?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [52]

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Yes. I think some of the areas where we can provide particular insight is that we have very deep knowledge of our customers' vertical workflows. So we have a team of people who regularly go out and live a day in the life of our customers so they can be working alongside a nursing hospital or doing ride-alongs with a delivery truck driver, or something like that to see how they are performing their duties and how we can apply technology to better help them make their operations more productive, but also improve the customer experience or the patient experience.

And then when you start leveraging the access to data that we have today that we didn't necessarily have the same, say, 5 years back, we can do more things around how we can offer greater insights into their business and enable our customers to be even more productive around those areas.

So I think we now have better access, and we've invested in the capabilities to help assess our customers' operations for how they can apply technology to achieve their business goals. So this is very much a part of how we want to engage with our customers, and some are more receptive than others, but it's been a great example of how we try to leverage the skill sets we have. And Joe, any further thoughts?

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [53]

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Yes. I'm so pleased that you noticed this. This has been a centerpiece of the transformation we've been driving our go-to-market. And we talked a lot about how we want to bring solutions to market, but not often how we do that and how we do that is exactly as you've mentioned that this example in Latin America highlights. When we take a solution like location solution to market, we spend a lot of time with the auto manufacturer understanding their workflow and advising them how they can optimize that workflow by knowing where all the parts are. Or when we're implementing a SmartPack solution, we run a pilot and then some intensive consultative work with the customer to help them understand how that will help them increase in their trailer load efficiency, for example. And so this is a centerpiece of what we're doing. We're dedicating close to 10% of our sales force are ready to this type of consultative selling and we expect that only to expand.

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Jeffrey Ted Kessler, Imperial Capital, LLC, Research Division - MD [54]

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Great. And can I have a follow-up on your -- any tweaks or any new trends that you were seeing in your partners program? It was -- obviously, it got off to a somewhat rough start years ago and then it kind of blossomed. What is going on right now in the partners program that has you believing that you can add -- it will be additive to your value proposition beyond what it's already done?

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [55]

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Yes. The partner program has been in place now for 3, 4 years. And it's been well accepted, I think, by our partner community. They believe it's adding value and helping to kind of structure how we work together. So we're not envisioning any, say, large changes to it. It is working well and we are helping drive more cross-sell, as an example, out of this. We've seen partners that sell more than one product. They have overall higher growth rates than the average growth rate of the partner. And we continue to add new partners to the program as we expand.

The one thing that we have put increasingly more emphasis on is our independent software vendors. So we commented a little bit on that earlier. But we see ISVs as an integral part of our overall partner program and our go-to-market capabilities. These software vendors are a big enabler of the Android transition also as they now have crossed more and more ridiculous, started to put their software from traditional legacy Windows environments to Android. And that's kind of one of the prerequisites for us being able to provide the Android devices on the back end of that. Any further comments, Joe?

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Joachim Heel, Zebra Technologies Corporation - SVP of Global Sales [56]

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Well, I think the main part that I would highlight is Zebra has been and has increasingly been, since at the Enterprise acquisition, a channel-centric company. So our channel centricity, the percentage of revenue we do to the channel is well over 80%. And every year, since the acquisition, that has gone up further. So our partners have noticed this. They have grown faster than the rest of the Zebra business. And not only that, but the registered partners and our largest partners have concentrated a larger portion of business with them. So this has been an attractive value proposition and journey for them.

And the changes that we have made recently were intended to make this even more attractive, I would say, in 2 ways. One is we've introduced some specialization, for example, in health care and in RFID. We've introduced specializations that allow partners who may not be among the largest partners, but have a specialty capability to be successful and flourish economically and that's attracted new partners to the program.

And the second one is there's a great deal of interest among the partners in the solutions that we have been talking about recently. And this has been, on the one hand, a blessing for us, but we've had to manage it carefully because onboarding partners into these complex consultative solutions conversations is more demanding and we can't do that in as broad based a way as we can with products. But for those partners that we've onboarded, this has been an attractive additional value proposition they can take to market and differentiate their business. So those have been some trends in the portfolio.

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Operator [57]

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And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to Mr. Gustafsson for any closing remarks.

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Anders Gustafsson, Zebra Technologies Corporation - CEO & Director [58]

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Thank you. I want to thank the Zebra team and our partners for a strong first quarter and solid momentum into Q2. We are looking forward to ringing the closing bell at the Nasdaq market site in Times Square tomorrow to celebrate Zebra's 50th anniversary and honoring all who have contributed to our company's growth and success over the past 5 decades. So have a great day, everyone.

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Operator [59]

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Thank you. Today's conference has now concluded, and we want to thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.