Zebra Technologies Corp

NASDAQ:ZBRA

Earnings Call Transcript 2021-Q1

[Operator]

Good day, and welcome to the First Quarter 2021 Zebra Technologies Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

[Mike Steele, VP-IR]

Good morning, and welcome to Zebra's first quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year.

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 Chief Financial Officer. Anders will begin with our first quarter results, and Nathan will provide additional detail on the financials and discuss our revised 2021 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions.

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

[Anders Gustafsson, CEO]

Thank you, Mike. Good morning everyone, and thank you for joining us.

Our team delivered exceptional first quarter results, with strong performance across the business, resulting in record sales and profits. For the quarter, we realized; adjusted net sales growth of 28% or 25% on an organic basis; and adjusted EBITDA margin of 25.3%, a 620 basis point year-over-year improvement; non-GAAP diluted earnings per share of $4.79, a 79% increase from the prior year, and strong free cash flow.

Our teams executed well to satisfy a stronger-than-expected recovery in demand from smaller customers through our distribution channel, and continued strong demand from large customers to digitize and automate their workflows in an increasingly on-demand economy. We realized strong broad-based demand with double-digit sales growth across our four regions, each major product and solutions category, as well as in all of our vertical end markets.

We also significantly expanded profit margins, driven by favorable business mix and lower travel expenses, while at the same time, we continued to invest in initiatives to drive sustainable profitable growth. Given our momentum and pace of innovation, we are increasingly confident in our growth prospects.

With that, I will now turn the call over to Nathan to review our Q1 financial results in more detail and discuss our improved 2021 outlook.

[Nathan Winters, CFO]

Thank you, Anders.

Let's start with the P&L on Slide 6. In Q1, adjusted net sales increased 28.3%, including the impact of currency and the Reflexis acquisition, and 25% on an organic basis, reflecting broad-based demand for our solutions. Direct sales to large customers grew double-digits, and we saw even higher growth from smaller customers through the channel, partially driven by pent-up demand.

Our Asset Intelligence & Tracking segment, including printing and supplies grew 21.4%, while Enterprise Visibility & Mobility segment sales increased 26.8%, driven by exceptional growth in enterprise mobile computing.

We realized strong double-digit growth in services and software. And also had strong growth in our RFID solutions, which is beginning to rebound from the depths of the pandemic. We recognized double-digit growth in all regions. In North America, sales increased 28%, with mobile computing, printing, services and supplies each growing double-digits.

In EMEA, sales increased 22%, with solid growth across all sub regions and solutions offering. APAC returned to growth with sales up 19% led by strength in China, Australia, New Zealand and India. Latin America also returned to growth in all sub regions, with sales increasing 31%.

Adjusted gross margin expanded 370 basis points to 48.9%, primarily driven by favorable business mix, and higher service and software margin. The favorable year-on-year impact from China tariffs was offset by $11 million of incremental premium freight charges. Adjusted operating expenses as a percentage of sales improved 280 basis points. We have been accelerating high return investments in the business, while prudently managing discretionary costs.

First quarter adjusted EBITDA margin was 25.3%, a 620 basis point increase from the prior-year period, reflecting higher gross margin and operating expense leverage. We drove non-GAAP earnings per diluted share of $4.79, a $2.12 or 79.4% year-over-year increase. EPS growth also benefited from lower interest expense and a lower share count, partially offset by a slightly higher tax rate.

Now turning to the balance sheet and cash flow highlights on Slide 7. We generated $214 million of free cash flow in Q1. This was $119 million higher than the prior year, primarily due to increased profitable growth.

In Q1, we had $13 million of venture investments in two companies that provide real-time asset visibility and artificial intelligence solutions. Our balance sheet remains strong. From a debt leverage perspective, we ended Q1 at a modest 0.9 times net debt to adjusted EBITDA leverage ratio.

Let's now turn to our outlook. We entered Q2 with a strong order backlog and healthy channel inventory levels. We're encouraged by the broad-based robust demand we are seeing across virtually every dimension of our business. As customers step up their plans to invest in digital transformation. This momentum along with our sales pipeline gives us the confidence to provide a strong Q2 guide and to substantially raise our full-year outlook.

In Q2, we expect adjusted net sales to increase between 38% and 42%. This outlook assumes a 450 basis point to 500 basis point additive impact from the acquisition of Reflexis and foreign currency changes. We anticipate Q2 adjusted EBITDA margin to be between 21% and 22%, which assumes gross margin expansion and operating expense leverage.

It also assumes approximately $18 million of premium freight expense, which is roughly the same gross profit impact we realized in Q2 2020 from the combination of premium freight, COVID mitigation and China tariff impacts. Non-GAAP diluted EPS is expected to be in the range of $4.00 to $4.20.

For the full year 2021, we are raising our guide for adjusted net sales growth to be between 18% and 22%, which reflects our increasing optimism for solid growth in the second half of the year, despite supply chain constraints from certain product components. This outlook assumes an approximately 3 percentage point additive impact from the acquisition of Reflexis and foreign currency changes.

We have raised our expectation of full-year 2021 adjusted EBITDA margin to be between 22% and 23%, which assumes operating expense leverage and meaningful gross margin expansion from the prior year. Despite an expectation for premium freight charges of $50 million to $60 million as we work to mitigate global supply chain challenges. We now expect free cash flow to be at least $850 million for the year, due to our revised outlook for increased profitable growth. Please reference additional modeling assumptions shown on Slide 8.

With that, I will turn the call back to Anders, to discuss how we're advancing our Enterprise Asset Intelligence vision in the markets we serve.

[Anders Gustafsson, CEO]

Thank you, Nathan.

I am encouraged by the strengthening demand across our business, which allows us to increase our 2021 outlook. Our team has done an outstanding job navigating us through the pandemic. Slide 10 illustrates how we are working with our customers and partners to advance our Enterprise Asset Intelligence vision.

By leveraging Zebra's leading portfolio of products, solutions, software, and services our customers can overcome some of their most complex operational challenges and transform their frontline workflows to achieve higher levels of performance.

Businesses across all industries are adopting solutions that digitize and automate their operations at the edge to help them compete more effectively in today's increasingly on-demand economy. With our innovative solutions, our customers frontline associates can now anticipate and react in near real-time, utilizing insights driven by advanced software capabilities such as machine learning, prescriptive analytics, and computer vision.

We have been making solid progress integrating Reflexis market-leading workforce management and real-time task management solutions with our existing software applications to optimize the experience for frontline workers, as well as reduce complexity for the corporate teams that support them.

Our value proposition is to ensure the best next action, where every worker is easily identified, assigned, and completed; leveraging artificial intelligence gathered from real-time inventory or point of sale data. We are receiving very positive feedback from customers on the software portfolio enhancements we have planned for this year, that will enable a unified experience across labor planning, tasking and workforce communications. We also continue to invest to accelerate the go-to market traction of our growing suite of solutions.

Slide 11 highlights how the pandemic has accelerated trends that have been driving our business. Consumers have been raising their service level expectations in this on-demand economy. Enterprises are investing in Zebra solutions with an increased sense of urgency, due to a significant increase in omnichannel shopping. Forecasts for global e-commerce sales and parcel shipping volumes to double over the next several years. Track and trace becoming increasingly important for a wide range of use cases. And healthcare patients seeking a more digital experience.

Automating strained workflows with proven technology provides an attractive return on investment. The benefits to the enterprise also include increased productivity and efficiency, as well as higher customer and patient satisfaction. These opportunities are not exclusive to large enterprise customers, as we are seeing similar trends with small and medium-sized businesses.

To capitalize on the favorable e-commerce trends I just mentioned. Yesterday, we announced the launch of Zebra's first cloud-connected label printer designed specifically for the small business home office customer, featuring eco-friendly cartridges and mobile application software to easily design, and print labels from anywhere.

With the launch of the ZSB Series printer, we enter an approximately $400 million market with an attractive recurring supplies revenue stream. We have been innovating at a record pace, despite the pandemic and this SOHO label printing offering is a proof point of our focus on expanding into attractive adjacent markets where we can provide a differentiated offering.

Now turning to Slide 12. We understand the operational challenges our customers face in the increasingly on-demand economy. As a trusted strategic partner, businesses of all sizes in a variety of end markets turn to Zebra to help optimize end-to-end workflows. In retail, there has been a sharp increase in omnichannel and online shopping.

To retain business, retailers need to deliver goods in a timely manner or make them available for pickup when promised. To address this challenge a wide range of retailers have been prioritizing investment in Zebra Solutions that provide higher inventory accuracy and utilize their labor more effectively.

For example, a leading UK supermarket chain recently purchased over 5,000 Zebra ZQ610 mobile printers, for nearly 1,400 stores and added thousands more TC52, TC77s and PS20s for their existing Zebra fleet of devices, to enable inventory management, omnichannel fulfillment, and other critical use cases across their operations. They are also evaluating Zebra's workforce management and scheduling software applications we use across all their stores.

Additionally, we have received very positive feedback from a large fashion accessories retail customer who has adopted our new option for Zebra prescriptive analytics to feed directly into our Reflexis workforce and task management software offering. Other retail customers are planning to adopt this capability soon to leverage the synergistic benefits.

In transportation and logistics, strong e-commerce adoption continues to drive exponential growth in parcel volumes, putting pressure on supply chains, even as they hire more workers. This is one of many reasons a wide variety of companies are attempting to digitize their operations with our technology.

A large car-rental company recently began deploying 5,000 ET56 Rugged Tablets at their airport locations to enable mobile associates to perform point of sale check in for improved customer service.

In healthcare, the need for real-time visibility into the entire patient journey, as well as the demand for technology that ensures safe and efficient care continue to make healthcare our highest growth end-market opportunity.

The top ranked U.S. hospital system recently selected Zebra's mobile scan and print solutions to integrate with their new electronic health record software application, where patient bedside care which enables positive Patient ID, specimen collection and medication verification. Zebra's easy-to-use mobility solution and device management applications allows this customer to streamline clinician workflows, increased accuracy, and enhanced safe patient care.

Although the manufacturing sector has been hardest hit in 2020, sales rebounded to double-digit growth in Q1. We are focused on increasing automation in workflows for our customers and have been recognized as a thought leader in this market. We recently secured a takeaway win with a global food manufacturer, who purchased more than 1,000 Zebra MC93 mobile computers and 8051 tablets.

This customer has been equipping an increasing number of associates with technology to enhance their manufacturing, shipping, and receiving workflows; ease-of-use, functionality, lifecycle management, and support were notable selection criteria cited by this customer.

In closing, we are performing well in our primary end markets, and we are excited about the emerging prospects we see in newer markets to digitize and automate workflows.

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

[Mike Steele, VP-IR]

Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible.

[Operator]

[Operator Instructions] And the first question today will come from Damian Karas with UBS. Please go ahead.

[Damian Karas, UBS]

So you had mentioned that some of the first quarter sales strength was on pent-up demand from your smaller customer base. But just thinking about the current order strength you're seeing as you progress through the second quarter, would you still characterize some of that as pent-up demand? Are we kind of past that at this point and it's really more reflective of your underlying run rate demand, if you will?

[Anders Gustafsson, CEO]

Well, and first, we are very pleased with our first quarter results here and the outlook we could provide. We - the business is supported by some strong secular trends that have accelerated during the pandemic, like omnichannel and - so most companies today are very focused on automating and digitizing their businesses. And for us, that resulted in double-digit growth across all regions, across all products and solutions, as well as all verticals, so very broad-based demand for us.

We did see particularly strong growth from small and medium-sized customers, and that was partly driven by pent-up demand, but it's only partly driven by pent-up demand. Yes, but - we also saw strong demand from our large customers, our larger strategic accounts. And I think another factor here was that based on our performance, I'm - I certainly expect that we continue to take share in the market.

Nathan, do you want to add something?

[Nathan Winters, CFO]

Yes. So this time on the pent-up demand. I think one, it is an estimate, so this isn't a precise deal reconciliation. And we think it is recovering most of our 2020 miss to our original plan and guidance last year and recovering that here in the first half of the year, which is contributing low double digits, both in the first and second quarter.

[Damian Karas, UBS]

Okay, that makes sense. And then, I think you spoke in the past that, sort of, later in the year is when you start seeing sort of the larger projects, if you will, larger orders. At this point, do you have some visibility there that you've kind of baked that into your guidance in the back half or should we still expect that there could be some larger projects that haven't taken hold yet?

[Anders Gustafsson, CEO]

I think what we've said is, it tends to be that our visibility into the larger deals or into our pipeline overall increases with time. So the closer - the further we enter the year we get better visibility, we'll have to be through the second half and Q4.

So part of what you see today is that we have gained some better visibility into both - how we expect the run rate to progress, but also on some of the larger deals. But we don't have perfect visibility, so clearly there is opportunities for deals that we don't necessarily have in our stored as high likelihood in our pipeline today.

Joe, do you want to add something to this?

[Joe Heel, Chief Revenue Officer]

Yes. I would say that the large deal momentum has continued evenly throughout the year. And we have prospects for large deals in the second half, just as we did in the first half. One of the large deals that you're aware of is the USPS deal, which is of course contributing to our Q2 and Q3 as we have said.

[Operator]

And the next question will come from Tommy Moll with Stephens. Please go ahead.

[Tommy Moll, Stephens]

Anders, it's sounds like compared to a quarter ago, when we talked both in terms of geography and market, it sounds like everything or nearly everything is better than expected, a quarter ago. But if you had to pinpoint maybe one geography or one end market that's improved the most, just as a driver for the raised revenue guidance, what would you point us to? And if I'm mistaken, and if there is any geography or end market that's gotten a little weaker over the last quarter that would be good to know. Although, maybe just based on your tone and comments today it sounds like there weren't any?

[Anders Gustafsson, CEO]

This is a hard question today, because we have broad-based demand. I don't think we've ever had a quarter where we've had each of our four regions, each of our verticals and each of our main product categories all growing double-digits. So it's hard to pick who stand out as particularly strong or weaker. But I'll probably just highlight maybe North America as particularly strong, as being also our largest region here, we grew by 28%.

So we saw very broad-based demand across basically all our portfolio, the entire portfolio. But printing supplies, mobile computing, RFID, services, software, they were all up double digits. And we had strong wins across all our vertical markets in North America. And our newest vertical, the government vertical also demonstrated good growth. And I think demonstrates the investments we've made in both product and the go-to-market for the government vertical paying off here now.

On a - from a vertical perspective, maybe healthcare, just want to highlight. It's been our fastest growing vertical for some time and we expect it to continue to be the fastest growing one. It had a very nice performance in Q1. I think the transformation in healthcare is accelerating. It started off in acute care, but it's moving into other areas now, like ambulatory care, contact tracing, even remote patient care. And healthcare patients are now expecting or demanding a more digital experience and they prefer that also.

And our purpose-built solutions are critical for healthcare providers to be able to improve the overall patient journey to drive - and to drive greater productivity for the healthcare providers across their operations. And some of our solutions in healthcare also used specifically, but for COVID response like drive-through testing and vaccinations, cold chain logistics and so forth.

[Nathan Winters, CFO]

Maybe I can add something too. If you look at the regions nominally, the one that's swung the most from last quarter was Latin America. Latin America was the one that was hardest hit in the pandemic and has rebounded the most, but it's also our smallest region.

In terms of verticals, another one that is notable is manufacturing, which was hit very hard in the pandemic as well and we're seeing some good rebound in that area. I think the biggest swing that we haven't mentioned yet is one of deal size and customer size, right? So, notably our run rate and the purchases by small and medium businesses have accelerated and are catching up now to what was a big driver in past quarters of the larger customers, investing in e-commerce and digitization. We're now seeing that in the small and medium business, which of course manifest in our run rate.

[Tommy Moll, Stephens]

Thank you, both. That's very helpful. If I could ask one follow-up. Anders, I wonder if you could update us on some of the pilots you have with retail customers, where all our or at least a lot more of the store associates are carrying one of your devices. What's the progress there? How are you making the ROI case to the potential customers? And to what extent does reflect this factor into the strategy there?

[Anders Gustafsson, CEO]

Yes. The device for all is a big opportunity for us. We're very excited about how that's progressing. We see the theme around how most companies wants to automate and digitize their operations is playing a big role in driving this. Across every vertical, I would say, our customers are looking to put technology in the hands of more of their employees and be able to have them be connected and be able to both enter data, as well as react to data.

We see the relationship with Reflexis as very synergistic. And that, if you have a mobile device you can now look at inventory stock-outs, or other information and upload that to the Reflexis task engine, which now can make smarter decisions, can prioritize the highest ROI action, and then mobilize that to the right worker at the right time by - through somebody who then is carrying a mobile device. So it's a very strong synergistic portfolio that adds basically - and the network effect it adds to the value of both device and both solutions by having both under one roof.

The progression on deeper penetration is also progressing. So if you go back, 7 years, 8 years or something, our large supercenter in retail might have had seven or eight devices and today they routinely would have maybe 70 or 80, but they may have several hundred employees. And we think that having a shared device for those associates when they are in the store is big objective for, I would say, the vast majority of our customers. And that's progressing.

We have some good examples of where we've provided - expanded our portfolio to provide that kind of full range of devices across the price and performance curve. And where we've combined software and devices to really enable much deeper penetration.

And Joe, maybe you want to share some examples of this?

[Joe Heel, Chief Revenue Officer]

Yes. I'll give you one example of the connection of our device for all and our SaaS software. One of the largest retailers in Australia is using our EC30 devices together with Workforce Connect to enable their associates to do tasks in the store, but also communicate with one another. And that's one of the key use cases, which is - and by the way also enabled by Reflexis in the future is to have the associates be able to interact with each other, which requires that all of the associates have a device. So, I think that's a pretty good example of it.

[Tommy Moll, Stephens]

Great. Thank you, both. We'll keep our eyes out for more progress on those fronts. But I'll turn it back for now. Thank you.

[Operator]

And our next question will be from Andrew Buscaglia with Berenberg. Please go ahead.

[Andrew Buscaglia, Berenberg]

I was hoping you could talk a little bit more on gross margins in the quarter, which were obviously very strong. Can you break out what - you mentioned software and then that Reflexis or just acquisitions in general helping? Can you break out what that contributed in the quarter?

[Nathan Winters, CFO]

Yes, Andrew, this is Nathan. Firstly, our teams have been executing very well on what we can control. You see that through the gross margin improvement year-on-year up 370 basis points. About two-thirds of that is related to business mix, as well as volume leverage. We have especially high mix of large orders, due to the recovering small and medium business that Joe mentioned earlier. And about a third of that was from expansion of our service margins, as well as the Reflexis acquisition. And most of that coming from expansion within our service business.

I think the one thing to also note, as we stated last year, we look at our underlying gross margin trends. They remained healthy throughout 2020. And we expected the overall margin and we're seeing that play out to improve as the mix has returned.

[Andrew Buscaglia, Berenberg]

And EVM had particularly very strong gross margins, 49%, is that sort of the run rate we're looking at going forward? I know you have those freight expenses coming in. But yes, is this sort of, kind of the path you're taking? Are you - do - you think you can grow or expand margins even from that kind of elevated level, given some of this software and services integration?

[Anders Gustafsson, CEO]

I think, over time, we do expect for our margins to improve. I'd say, Q1 was especially favorable due to the strong mix of small and medium-sized business. But I think as that normalizes to more of a normalized level as we move forward, we do expect EVM margins to improve over time, particularly as you mentioned with the growth and expansion of our software solutions.

[Andrew Buscaglia, Berenberg]

Okay. And maybe just last one. In Q2, stuff got into that guidance unless you - if you assume a pretty big ramp in SG&A? So, do we expect a step down in gross margins just in Q2, for some reason or given the freight expense?

[Nathan Winters, CFO]

Yes. So if you look at our Q2 EBITDA guide of 21% to 22%, it is up nearly 3 points year-on-year due to favorable business mix from 2020. Sequentially, it is down 4 points, most of that is due to lower gross margin. As we said, as deal size, I think, comes back from the exceptionally high level we are - we had here in Q1. And you also have CRS seasonality, a slight care for recovery in the first quarter all lowering gross margin sequentially. As well as we do expect higher OpEx, as we continue to accelerate investment in our new solutions both in R&D and go to market.

[Operator]

And the next question will come from Jim Ricchiuti with Needham and Company. Please go ahead.

[Jim Ricchiuti, Needham and Company]

Just wondering if - what kind of headwinds you might be seeing or anticipating for the full year, just as it relates to what we've all been hearing about component constraints, higher raw material prices? And just along those lines, do you anticipate potentially having to take any pricing actions going forward just given the supply chain issues?

[Anders Gustafsson, CEO]

Yes. I would first characterize the supply chain issues that we're working on in two categories. One is, logistical bottlenecks and the other one is around the industry-wide semiconductor shortages that has been in the press quite a bit lately. First on the logistical bottlenecks. That's really caused by an increase - a combination of increase in demand when combined with a reduction in commercial air traffic sort of fewer commercial airplanes, which used to cover or carry a lot of commercial freight also. Then you have - add on a little bit of container shortages and port congestion on top of that.

But this has resulted in air and ocean rates on - pretty much on all our key routes, having increased by a factor of two, since the start of the pandemic. So, we are incurring premium freight cost as a result of this. And we are prioritizing customer - meeting customer expected delivery dates. So, we have been using - leveraging all modalities of freight to get our devices and products to our customers, including chartering flights from Europe - from China to Europe and the US. But this has had a negative - a negligible impact on revenues.

And I'd say, our supply chain team has done an outstanding job of being able to manage this and minimize the impact on the business. They had issues around the semiconductor shortages and this impacts some of our products more than others. Our teams are - have been doing a great job of managing all angles of optimizing allocations for us. We have a history of thoughtful contingency planning, which I think is helping us here.

We tend to qualify multiple components when we can and even have multiple suppliers when practical. We have seen, again, modest increases in surcharges related to sourcing these components. But despite the - both of these issues that I mentioned, we are confident in the full year sales outlook that we gave. The outlook incorporates both of these points.

And lastly then on the price action you asked about. We continuously assess pricing based on the competitive environment. So, we always look at that, but there is - we have no imminent plan of addressing or having, let's say, a broader price increase to address these supply chain issues.

[Jim Ricchiuti, Needham and Company]

And thank you. And the follow-up. Just on the AIT business. And I'm just wondering how - what you're seeing in the market - in the legacy - this legacy part of your business compares with previous recoveries and other economic cycles?

[Anders Gustafsson, CEO]

Yes. We had an exceptional quarter for print. The growth rates were well above average - corporate average. We - as we saw growth across the portfolio and certainly pent-up demand had been an issue here. Smaller customers through the channel, it was recovering quite nicely. And we also over the last year or so, taking some steps to strengthen our go-to-market around our eco channel - channel ecosystem.

And I think that's made us more competitive. And we've been able to accelerate some share gains. Our printing - RFID printing business was also particularly strong. And even the supplies business was doing very well. Tempt time was up double digits. So it was a very strong performance across the board.

And maybe also highlight that, Joe mentioned earlier, the manufacturing was up very strongly in Q1 after having had a tougher go in 2020 and a little bit further - beyond that also it would further that out. And printing is the most exposed to manufacturing. So when manufacturing goes up that would have a disproportionate impact on our printing business.

[Operator]

The next question will come from Meta Marshall with Morgan Stanley. Please go ahead.

[Meta Marshall, Morgan Stanley]

A quick question. Some of these smaller customers come back. What are they asking you for that may be different from - what they were asking you from before. Clearly, they still going to face some challenges in the competitive environment. Just wondering, what they're asking you for in particular? And then maybe on the healthcare opportunities. Just as you move past some of these kind of COVID boosted use cases, where are you seeing the most traction in these cases there? Thanks.

[Anders Gustafsson, CEO]

Yes. I will start, and then, I will ask Joe to also provide some color here. So first on smaller customers and what we're seeing, what's different. I'd say two things, Meta. One is, irrespective of size, I would say, pretty much all customers across all verticals are looking to figure out how can they digitize and automate their businesses more.

And they do look to our type of solutions to connect the physical world to the digital world, to really help them connect that physical workflow - those workflows into applications and automate them better. So that is a broad-based theme across basically all sizes of customers and verticals.

The other point that would be - our larger customers who generally able to pivot to a COVID operating world better. They were generally seemed to be essential businesses - were deemed to be essential business, while many of our smaller customers, many of them are in manufacturing had to shut down. And now as they come back, I think they are looking to make investments that enables them to compete with some of their larger presence who have made more - who have invested earlier in those digitization and automation themes.

Joe, do you want to add anything to this?

[Joe Heel, Chief Revenue Officer]

I think you said it well on the small-and-medium businesses. Clearly, the pent-up demand portion of - we're still most pronounced among the SMBs, I would say, and they're catching up more on their pent-up demand. But beyond that, it is really those small-and-medium businesses going to the next level of digital transformation, just as their larger resident have.

And you get also asked about healthcare. And - on the healthcare beyond COVID 19 use cases, we're seeing an expansion, as Anders has mentioned in the prepared remarks into new areas of healthcare like ambulatory care, like remote patient care.

So the use of tablets, for example, in order to enable remote patient care is a big use case. Communication, of course, is the big use case. And one that we're also seeing a lot of interest in is, asset and people tracking in hospitals, locating the right person, or locating the right asset for a particular procedure. Those are new use cases and are driving some of that accelerating demand [indiscernible].

[Operator]

And the next question will come from Keith Housum with Northcoast Research. Please go ahead.

[Keith Housum, Northcoast Research]

Good morning guys, and congratulations on a great quarter, and the solid guidance. Just want to unpack the gross margin growth, again, just a little bit more? Software and services obviously had a great step up compared to in the fourth quarter or in the first quarter last year. And I understand last year's step up was due to European services improvement, something that's getting further improvement this time around. And this 47%, roughly, gross margins, is that sustainable going forward? Is this like a new normal for you?

[Nathan Winters, CFO]

Keith. So just - first part of your question, to the growth in both our service and software. Now again, seeing on both ends, right at the - the addition of Reflexis gross margin being higher than the company average is helping. But also from an organic basis, up nearly 7 points year-on-year from our core service business. And part of that is due to the actions we took over the last several years to improve efficiency and streamline the repair operations and the team is continuing to work that.

And then the other is, now with double-digit revenue growth, I've seen that volume leverage flow through the P&L is the other big driver of the margin improvement. And we do expect that to continue to grow year-on-year as we grow the top line, as well as improve efficiency in the operations.

[Keith Housum, Northcoast Research]

Great to hear it. And then, in terms of your overall growth, I understand there's multiple drivers of your revenue growth. But can you touch on perhaps the growth that's been contributed from the new products and perhaps expansion into new markets that you're perhaps, we're not doing as well in before? Just trying to dimensionalize some of the growth aspects there?

[Anders Gustafsson, CEO]

Yes. So, when you say new products, you mean new types of solutions, or were just new products more generally?

[Keith Housum, Northcoast Research]

I mean, more types of new solutions, looking for new customers, new use cases. And perhaps, your prior generation of products that did not have previously addressed.

[Anders Gustafsson, CEO]

Okay. Yes. I'll start and Joe, you can provide some - year also. So I'd say, we did see RFID having a very strong quarter in Q1. RFID had a tough going last year, but that's really started in Q2. So there was - Q1 last year was more of mill, was pretty reasonable quarter. So this is a strong rebound for RFID. And we see these types of solutions which are more contactless is having a great - being in demand and see more deployment of them.

I would say, also our software solutions are having great traction. The combination of the Reflexis, Zebra Prescriptive Analytics and Workforce Connect provides a very differentiated value proposition for us. And each of those offerings by them - and of themselves are performing very well. But when you then combine it with as a suite and then look at the - how they interact with our mobile devices that provides a very compelling offering, which we see having great, great opportunities for us to continue to grow.

And some of our other intelligent edge solutions are still probably a little slow in ramping as we've had - still have a hard - we don't have access to our customers' facilities to the extent we used to, to do pilots and proof of concepts and other types of engagements like that. But we expect that to ease up here as we get through COVID and get back into more normal way of operating with our customers.

Joe?

[Joe Heel, Chief Revenue Officer]

Yes. I'll add - maybe add a couple of things that could be helpful. In terms of the mobile computing segment. We talked about the device for all. And as Andrew said, previously described, we are seeing an expansion of this. This isn't necessarily always a big game, where someone just rolls out devices to everyone. But an expansion to additional sets of people, right? That you can - now you use it for transport in a hospital, not just for nurses, for example.

So that's been a big expansion. But we've also had some very innovative use cases. One of them, we recently published in the press release for a tire change, that is now using our devices to not only keep track of the tires in the inventory, but also measure the tread gap and offer a new service to a customer. That type of innovation, I think is, is going to be providing new use cases as well.

And I'm also quite proud of our ability to grow the tablet segment, that we accelerated through the acquisition of Xplore some time ago and to combine with our own ET tablets, and we have some very good traction there.

From a vertical perspective, two that I would call out is the government and healthcare segments. The healthcare segments have seen a good acceleration internationally. You know that we've always had a reasonably strong position in North America. But now we're seeing deals in Japan and Australia, in the U.K. that are sizable, right, where these institutions are modernizing their infrastructure globally.

And government is, we've mentioned is an area, not just in the U.S., but also in other countries again, around the world that we've made substantial go-to-market investments, and we're now seeing accelerated growth. Most of the mobile computing, but also some printing opportunities with governments around the bar.

[Operator]

The next question is from Richard Eastman with Baird. Please go ahead.

[Richard Eastman, Baird]

Yes, good morning. Just very quickly on the gross margins. It - did the chair - the China tariff benefit, did that all fall into the EVM gross margin?

[Anders Gustafsson, CEO]

It would have fallen between both EVM and printing. So we had both - I don't have the exact split off them, but it was...

[Richard Eastman, Baird]

Okay.

[Anders Gustafsson, CEO]

So equally - or proportionately weighted between EVM and AIT.

[Richard Eastman, Baird]

Okay. And then just - is there any visibility on that? I mean, going forward, Q2 to Q4, is that benefit continue?

[Nathan Winters, CFO]

But, do you expect the benefit to continue? We have not included that into our guidance for the quarter or the year in terms of incremental benefit. As - quite frankly, it's very hard to predict when and how the claims we've processed will be approved and paid. But it's something we continually work and actively manage. But yes, it's pretty tough to predict the timing of when we expect to get the recovery from the government.

[Richard Eastman, Baird]

I see. Okay. And then just, just maybe as a second question around the core growth in the quarter was 25%, I believe. Could you just speak to what the growth relative in the channel was versus direct? And does the U.S. Postal Service fall in the direct piece that you're going to hopefully define for me?

[Anders Gustafsson, CEO]

Yes. I'll - I think, Joe can probably provide most colors. But the USPS will be in Channel customer, I think, Joe. And second, our Channel business had a fantastic quarter, with I believe stronger growth than what we had in our direct accounts.

Joe?

[Joe Heel, Chief Revenue Officer]

Yes, I can confirm that. So our strategy has and remains to be Channel-centric, with the vast majority of our revenue going through the Channel. And I'm happy to report that our Channel has once again grown faster than our business overall, and has therefore expanded the portion of revenue that goes through the Channel.

[Richard Eastman, Baird]

Is - and just lastly, and related to this. I've got a question on just the press release that came out a little bit ago here, kind of mid -April. But you talk about this PartnerConnect Alliance Track. And it's complementary to the independent software vendor track. But just talk about maybe this expansion of non-selling VAR partnerships. And just, what that brings to the table here? And is that, there is an investment made in these channels? But just, maybe just speak to that, how that expands the opportunity set for Zebra?

[Joe Heel, Chief Revenue Officer]

Do I need to take that, Anders?

[Anders Gustafsson, CEO]

Yes, please.

[Joe Heel, Chief Revenue Officer]

Yes. Of course, VARs has been the core of our PartnerConnect program. We've added ISVs, especially in the Android transition because of the importance that the software that runs on our devices has and how the customer comprehends that as an integrated solution and wants to buy it that way. So we recognized ISVs as influencers of the customers, aligned ourselves closely with those and, and are proud to have some of the largest ISVs in our program. But we've also recognized that there are other important influencers.

I'll give you an example to make this real, which is, if you think about network equipment providers. People that provide WiFi infrastructure, for example, for a customer. Almost similar to the ISVs. They are looking to provide solutions to customers, like for example, locationing capabilities, right, within the environments that they outfit. And by working with us, they can enable such solutions. And we recognize that and created this Alliance Track in order to allow us to work more effectively with those kinds of partners. And it's paying off very nicely for us.

[Richard Eastman, Baird]

So it's basically lead generation. I mean, is that what you look to it? These other influencers around ID products?...

[Joe Heel, Chief Revenue Officer]

It is lead gene... I'm sorry, go ahead.

[Richard Eastman, Baird]

No, that was my question.

[Joe Heel, Chief Revenue Officer]

Yes, it is lead generation, but it is perhaps even more effective in allowing us to close the opportunities, right? When a customer sees that we're aligned and that we're working together, we have a greater chance of winning.

[Operator]

The next question will be from Brian Drab with William Blair. Please go ahead.

[Brian Drab, William Blair]

Just first on the EBITDA margins. I guess the full-year guidance implies that the - first of all, you gave us the 21.5% midpoint for the second quarter, but then the full-year guidance implies the same kind of 21.5% level for the third quarter and fourth quarter. I'm wondering if that's kind of fair to assume that, that will be the run rate for the balance of the year and no big swings between third and fourth quarter?

And also, is the premium freight headwind something that will persist or is that - can that fall off maybe later in the year? And I'm just wondering, how much conservatism might be baked into that 21.5% after putting up 25.5% almost in the first quarter?

[Nathan Winters, CFO]

So if you look at our full-year guide of 22% to 23%, we do expect gross margin in that to improve year-on-year, and particularly our software solutions grow. And we do expect premium freight cost of $50 million to $60 million, which we've raised by $20 million and most of that coming in the second half. Because we really don't see any change in those expectations from what we're seeing here in the first half, or at least it's hard to predict when the - particularly the supply side will come back around commercial air travel. And that's also $20 million higher than all of our 2020 transitory costs, including tariffs.

And we also expect to continue to invest in and grow OpEx as we accelerate investment in some of the high ROI opportunities and including the continued integration of our software offerings with Reflexis.

[Brian Drab, William Blair]

Okay, thanks. And then, can you provide some details on the competitive environment as you're seeing it? Anything you can share in terms of what your share of the mobile computer market is now from your perspective and what your share of the bar coding equipment market is? Just that so much has changed in the last year with the industry just exploding.

And then also within mobile computing, can you talk about what percent was Android versus Windows-based in the quarter? Thanks.

[Anders Gustafsson, CEO]

All right. I'll start and we'll see if I missed anything. But if - so competitive environment. First I'd say, we are very confident in our competitive positioning. I'd say as confident as we've ever been probably. We're coming out of COVID 19 with good momentum and it provide - we've actually gained share as we've gone through last 2020 here. We took the attack of continuing to invest in new solutions and staying as close as we could with customers. We actually launched more new products last year than we've done in the other year in history, and I think that's coming back to benefit us here now.

Our markets are, we think very attractive. We have some strong secular growth trends. I mentioned kind of the trends around digitizing and automating workflows as a broad theme that I think that's something that's very broad-based and very - we believe will be something that companies will invest in for several years. The - we have some strong advantages also. We have our scale, our go-to-market network, the ecosystem we have there. So there is a number of things that will make us a formidable competitor from that perspective.

And lastly, I'd say our vision. Our Enterprise Asset Intelligence something that differentiates us from our competitors. When our customers look, talk to us, they are not looking to just buy device for here and now, they are looking to see how they can partner with somebody who can help them drive that digitization and automation of their operations into the future.

From a share perspective, we get share data from independent sources and they tend to lag. So we only have Q4 data. But we had a record share in mobile computing over, I think it was over 50% on print and we - the Number 2, I think is, I believe 12%, certainly directionally in that area. On print, we have a low 40%, 43% I think it is...

[Nathan Winters, CFO]

Yes.

[Anders Gustafsson, CEO]

And our next second competitor is low double digits. I think also about 12%. And in scan, we have about 30%, where the second largest is more like 24%. So, we have strong position across our business.

And your last question was about the mix of Android and - Windows. And we now have over 85% of our mobile computing sales are Android.

[Operator]

Please proceed Mr. Anders, if you needed to answer the question further.

[Anders Gustafsson, CEO]

Well, I just - our share in Android remains particularly strong. We probably have approximately 60% of the share of Android, so we're particularly strong in that Android element.

[Brian Drab, William Blair]

Yes. That's a good answer.

[Operator]

Thank you, sir. And the final question will come from Blake Gendron with Wolfe Research. Please proceed.

[Blake Gendron, Wolfe Research]

Thanks for squeezing me on here. I want to start with cash flow. So relative to the wording of at least $700 million in the prior guidance, the current guide is appreciably higher. So I'm wondering, how we can think about free cash conversion in the context of both, Number 1 growing software mix and Number 2, the healthy channel growth that you mentioned. I would imagine that hardware-led pent-up demand recapture would see some working capital drag in 2021. But as we look into 2022 and beyond, is there a way we can think about free cash conversion that's perhaps structurally different from what it's been in the past?

[Nathan Winters, CFO]

And so, the first part of your question is just in terms of the full-year guide of greater than $850 million really just aligns to the increased profitable growth outlook for the year. So no notable changes in - from a working capital perspective relative to our last guide. Our target year in and out - year-in and year-outs be at 100% free cash flow conversion. This year it'll be slightly lower than that just because of the strength we had in 2020. But we don't see that noticeably changing and something we can achieve over time as we look - as we move forward.

[Blake Gendron, Wolfe Research]

Okay, that's helpful. And then one quick follow-up here. Interesting win with the tire customer. And that application seems like if all the machine vision - there is a large machine vision competitor, that is a small handheld scanner device. Business somewhere in Zebra's purview, there's a little bit of overlap. Do you think that this overlap increases, particularly in the manufacturing realm? Is there any M&A to do here? A lot of what we're hearing in terms of automation, AI deployment within the manufacturing facility is coming from the Machine Building customers, which seems like it's on the periphery of what Zebra does, but that would be helpful perspective.

[Anders Gustafsson, CEO]

Yes. Machine vision is a very exciting, sensing and data acquisition technology for us that helps us enable intelligent automation solutions. We've already incorporated machine vision into a number of our solutions like SmartPack, SmartSight, our MP7000 flatbed scanners for the color camera.

So, we just clearly see great opportunities to continue to leverage machine vision to create unique solutions for our customers. The tire tread depth sensor, that is an accessory that we put on our mobile computers to be able to do, but it's another example of how we're trying to find use cases where we feel that we have a strong right to play and where we can be competitive.

I now expect that machine vision is going to be continued area for us to invest. We acquired a company called Cortexica about 18 months back, I think it is now, that was basically as an engineering team that has deep expertise into machine vision. Their focus was on figuring out how to extract useful information from digital images and video and we put - they put, they have been a great addition to our team and helping our other solutions - accelerate the deployment of our other solutions.

[Operator]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks.

[Anders Gustafsson, CEO]

Yes. So to wrap up, I would like to thank our employees and partners for their focus, dedication and resiliency, leading to exceptional Q1 results and an improved outlook for 2021. Our top priority continues to be protecting the health and well-being of our employees, partners, and customers as we recover from the pandemic. Stay safe everyone.

[Operator]

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