Zebra Technologies Corp

NASDAQ:ZBRA

Earnings Call Transcript 2018-Q2

[Operator]

Good day and welcome to the Second Quarter 2018 Zebra Technologies' Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

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

[Michael A. Steele, Zebra Technologies Corp.]

Good morning and thank you for joining us. Before we begin, I need to inform you that certain statements made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission.

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

This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Olivier Leonetti, our Chief Financial Officer. Anders will begin by discussing our second quarter 2018 highlights. Olivier will then provide more detail on the financials and discuss our third quarter and full-year 2018 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 and on a constant currency basis. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year.

Now, I will turn the call over to Anders.

[Anders Gustafsson, Zebra Technologies Corp.]

Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered excellent second quarter results. We executed well, driving strong profitable growth and further extending industry leadership.

As you can see on slide 4, we reported net sales growth of 13%, nearly 11% on a constant currency basis; an adjusted EBITDA margin of 19.7%, a 200 basis point year-over-year improvement; non-GAAP diluted EPS of $2.48, a 64% increase from the prior year; and $150 million of cash flow from operations.

We achieved double-digit sales growth in EMEA and North America. We also saw solid growth across all of our major product and service categories, including data capture, mobile computing, our specialty printing portfolio, supplies and support services. The investments we have been making in our best-in-class products and solutions are paying off. Our broad suite of purpose-driven products, enhanced with the smartest software and security features, is resonating well with enterprise customers.

Our operational discipline and lean cost structure enabled us to significantly expand profit margins and drive improved operating cash flow. Our strong results and robust order backlog gives us confidence to significantly increase our full year outlook for sales and free cash flow.

With that, I will now turn the call over to Olivier to review our financial results and to provide the details of our revised 2018 outlook.

[Olivier Leonetti, Zebra Technologies Corp.]

Thank you, Anders. Let us begin with the walk through the P&L. As you can see on slide 6, sales grew 10.6% in the second quarter, driven by solid results in each of our reporting segments and across all major categories. Enterprise Visibility & Mobility segment sales increased 10.9%, led by strong demand in data capture solutions and mobile computing. Asset Intelligence & Tracking segment sales increased 9.9%, driven by strong growth in printing solutions.

Turning to our regions, sales growth in North America was 11%, driven by outperformance in our data capture, printing and supplies categories. We saw particular strength in our transportation and logistics and manufacturing verticals.

EMEA sales increased 14% with broad-based strength across all geographies and all major product categories. We saw especially strong demand in the transportation and logistics space as well as in retail as investments are made to improve omni-channel capabilities.

Sales in our Asia Pacific region were up 8%, driven by broad-based strength across Asia, including China. As a reminder, Asia Pacific sales in the prior-year quarter were positively impacted by 3 percentage points related to the release of a reserve for price concessions related to previously imposed duties on printers in China. We had solid Q2 sales growth in China, despite this challenging comparison.

Latin America sales decreased 1%, primarily due to temporary softness in Mexico.

Adjusted gross profit increased $60 million or 15% (sic) [14.5%] (06:15) from the prior-year period on higher sales volume. Adjusted gross margin increased 70 basis points, primarily driven by improved go-to-market execution, favorable business mix shift and the appreciation of the euro over the past year.

Adjusted operating expenses increased $20 million from the prior-year period, primarily reflecting growth in the business, higher incentive compensation expense due to improved business performance and investment in growth initiatives.

Second quarter 2018 adjusted EBITDA margin was 19.7%, a 200-basis-point increase from the prior-year period. This was driven by higher gross margin and operating expense leverage on higher sales. In addition to EBITDA margin expansion, lower interest cost and a decreased tax rate drove non-GAAP earnings per diluted share to $2.48, a 64% year-over-year increase.

Turning now to the balance sheet and cash flow highlights on slide 7, in the first half of this year, we paid down $235 million of debt principal, supported by strong free cash flow of $233 million. This $52 million increase in free cash flow as compared to the first half of 2017 was primarily driven by increased operating profitability and the absence of integration cost in the first half of this year.

At quarter-end, we had $2 billion of viable rate debt on the balance sheet, of which more than $500 million is hedged with interest rate swaps for 2018. As a reminder, in late 2017, we locked in an incremental $800 million of floating-to-fixed rate swaps that will become effective in December 2018 for an overall notional swap value of $1.3 billion.

Due to the favorable timing of this transaction, we have realized $18 million of non-cash gains in the first half of the year, which we have excluded from our non-GAAP results.

Slide 8 shows our path to financial deleveraging. Continued debt paydown and strong EBITDA growth enabled us to achieve a 2.5 times net-debt-to-adjusted-EBITDA ratio as of the end of Q2, which is the top-end of our targeted range of between 2 times and 2.5 times.

In the second quarter, we completed additional actions to restructure our debt, which have resulted in an annualized interest expense savings of approximately $4 million to $5 million. These actions followed a comprehensive debt restructuring we completed during the second half of 2017, which drove more than $45 million of annualized interest savings.

Let us turn to our outlook on slide 9. We had a strong backlog entering the third quarter and we expect third quarter 2018 net sales growth to be between 12% and 15%, which assumes an approximately 1 percentage point favorable impact from foreign currency translation.

Third quarter 2018 adjusted EBITDA margin is expected to be between 19% and 20%, assuming gross margin in line with the prior year and increased operating expense leverage. Non-GAAP diluted EPS is expected to be in the range of $2.50 to $2.70.

For the full year, we are raising our outlook and now expect net sales growth to be between 10% and 12%. This includes an anticipated 2 percentage point favorable impact from foreign currency translation. Full-year 2018 adjusted EBITDA margin is expected to be approximately 20%, assuming higher year-over-year gross margin and operating expense leverage.

For the full-year 2018, we now expect to exceed $525 million of free cash flow. This increased outlook is primarily due to higher expected EBITDA. You can see other full-year 2018 modeling assumptions on slide 9.

Note that we have made modest adjustments to our assumptions on capital expenditures, interest expense, stock-based compensation and tax rate. Note that our 2018 outlook does not include any projected results from the acquisition of Xplore Technologies, a transaction we expect to complete this quarter. Anders will discuss the acquisition in a few moments.

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

[Anders Gustafsson, Zebra Technologies Corp.]

Thank you, Olivier. We are pleased with the progress we made in the second quarter and the opportunity to raise our full-year outlook. As you see on slide 11, we remain focused on our key priorities to build upon our industry leadership in 2018 and beyond.

First, we continue to extend our leadership through our innovation, unmatched scale and strong relationships with customers and partners. We saw strong demand for our products and solutions, both the direct and through the channel. Several areas that have recently been driving solid growth include our families of Android mobile computers, our best-in-class wearables, our tabletop and mobile printers, our next-generation bioptic grocery scanner and our Personal Shopper Solution.

Second, we are focused on driving growth in attractive markets where we can leverage our competitive advantages. We continually evaluate organic and inorganic opportunities to strengthen or augment our position in the adjacencies as well as attractive businesses that advance us as a solutions provider. As a proof point, in July, we launched a tender offer to acquire Xplore Technologies, which will enhance our product lineup and provide a complete enterprise tablet portfolio.

Xplore's offerings will serve existing vertical markets for Zebra as well as provide an inroad into new markets, including oil and gas, utility, government and public safety. The addition of Xplore will provide access to a great team and outstanding products in an attractive market that should enable us to grow our tablet sales double digits.

Third, we are advancing our Enterprise Asset Intelligence or EAI vision by leveraging Zebra's deep knowledge of workflows and capitalizing on key technology trends, including the Internet of Things, cloud computing and mobility. Our aspiration is to enable every frontline worker and asset to be visible, connected and optimally utilized.

Lastly, we have enhanced Zebra's financial strength and flexibility by increasing cash flow and optimizing our capital structure. As Olivier mentioned, we have achieved the top-end of our targeted leverage range after several years of EBITDA improvement and aggressive debt paydown. Last week, we were excited to introduce a new brand positioning that highlights our EAI vision and how we enable our customers to succeed.

On slide 12, you see our brand essentials, which convey how Zebra delivers a performance edge to the frontline of business. First, Zebra innovates products and solutions with purpose-driven designs that are tailor-made for the frontline and its work flows. Our products are ultra-rugged and reliable, intuitive to use and easily integrated with other Zebra products to create a scalable platform. They also have enterprise-grade security and are fully supported by Zebra through their lifecycle.

Second, our smart products and infrastructures capture timely and relevant information creating data-powered environments, supported by Savanna, our data services platform.

Third, we enhance collaboration and workflows for frontline workers through mobile connectivity. With our tools and software applications, teams can communicate seamlessly and utilize location information to dispatch instructions to the appropriate employee.

And, lastly, we can analyze the operational data we collect through automated methods to provide real-time guidance to the frontline worker. Together with our growing global ecosystem of partners, Zebra's solutions are used to intelligently connect company assets, data and people in collaborative mobile workflows.

In summary, these brand essentials highlight Zebra's differentiation in the marketplace and how we enable our enterprise customers to enhance productivity, improve customer service, ensure patient safety and comply with regulations. Across all of the vertical markets we serve, five mega trends have been transforming the needs of our customers. These include the proliferation of connected devices, mobility within the enterprise, cloud computing, the transition from task worker to knowledge worker and an increasingly on-demand economy. We are helping companies across many industries digitize their operations and improve their performance to stay relevant and compete in today's marketplace.

Slide 13 highlights the primary vertical markets that we serve, retail and e-commerce, healthcare, transportation and logistics and manufacturing. Our intimate knowledge of operational workflows in each of these verticals is a key reason for our success. We see the pace of change accelerating and the use cases are evolving to address increasing demands.

For example, in retail, our solutions have been traditionally used for inventory management, which remains a critical application for omni-channel and e-commerce fulfillment. More recently, we have been driving increased demand for our products and solutions in the front of the store as customers require a higher level of customer service, including more pick-up and delivery options. With our technology, a store associate can immediately check inventory and complete a transaction without ever leaving the shopper's side.

In the transportation and logistics space, we are well-known for track and trace and proof-of-delivery use cases. We are now providing real-time visibility of parcels and equipment at every stage of the supply chain, including innovative solutions that maximize the load density of a trailer.

In healthcare, we enable patient identification through wristbands and a variety of sensing technologies and we are expanding use cases by driving increased clinical collaboration. Our solutions now allow care providers to monitor patient conditions while being mobile. Additionally, enabling immediate communication among various care team members is vital for timely patient care and the best possible outcomes.

In summary, enterprise customers are working with us to solve their evolving business challenges. We see ample opportunity for increased application of our solutions in our existing and new verticals.

With that, I'll hand the call back to Mike.

[Michael A. Steele, Zebra Technologies Corp.]

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]

We will now begin the question-and-answer session. And our first question comes from Jim Ricchiuti of Needham & Co. Please go ahead.

[Jim Ricchiuti, Needham & Company, LLC]

Thank you. Good morning. I was wondering – I have a question on the transportation and logistics and manufacturing markets. What I'm wondering is whether the strength you're seeing in these markets is the result of new capacity additions or increased investments going into existing infrastructure and facilities. And you may not have that clear a pipeline into that, but I'm just wondering if that's what you might be seeing in those markets that's driving the strength.

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. Thank you. I'd say, first, our solutions are foundational to our customers executing on their strategies and digitizing their businesses across all our verticals. Across all the markets we serve, we help them increase workflow efficiency, provide real-time guidance to frontline employees and enhance customer or patient experiences. And we deliver all of this through our specialized partner ecosystem.

So, specifically, for the transportation and logistics and manufacturing markets, I'd say, first, with T&L, there's some strong secular growth trends that are in play there. E-commerce and the on-demand economy are driving a lot of investments by T&L companies. Historically, they've delivered many – say, many boxes to a few corporate enterprise customers. Today, it tends to be much more – a few boxes to many consumers.

So, it puts a lot of strain on their supply chain and that's translating into additional investments and business for us. So, our Android portfolio, our wearables, our printing, particularly mobile printing, are all seeing accelerated growth rates from the T&L space. And we see some of our newer solutions, like SmartPack and Location Solutions, demonstrate the thought leadership within the T&L industry. So, it helps also provide a bigger umbrella from how we can operate with those customers.

And in manufacturing, it's a strong growth vertical, particularly for printing, and we have released a number of new printers over the last several quarters, new tabletop printers and desktop printers, some new mobile printers too for that matter. And they have been very well received in manufacturing. We also see manufacturing as being the highest Windows conversion opportunity, so Windows to Android. They've been so far, I think, the slowest to adopt Android, but we are having a lot of programs and solutions in place to help make that transition as easy for them and help accelerate that. Manufacturing is also the primary vertical for our Location Solutions business.

[Jim Ricchiuti, Needham & Company, LLC]

Got it. My follow-up question, Anders, is on M&A. Just with the successful integration of the Enterprise business and now this announcement with respect to Xplore, I'm wondering if this signals that the company is going to be more active on the acquisition front. And along those lines, what's the deal pipeline look like and maybe some criteria for doing M&A going forward. Thank you. And congratulations on the quarter.

[Anders Gustafsson, Zebra Technologies Corp.]

Thank you. Yeah. Well, we now been – spent last three years aggressively paying down debt and that's giving us a lot of financial flexibility. So, we're now, as we said in our prepared remarks, at the high-end of our targeted net-debt-to-EBITDA range of 2 times to 2.5 times. We are seeing number of good opportunities for us to invest in our business both organically and inorganically. And these opportunities would deliver attractive ROI for our shareholders. I think Xplore is a great example of this. It's the first acquisition we made since 2014. So, it's basically four years.

All our investment opportunities, organic or inorganic, have to drive attractive ROI and attractive growth rates for us, both on the top and bottom lines. We always start by looking at the highest risk-adjusted returns for shareholders. So, we consider all options when it comes to our capital allocation priorities and investment opportunities that we will be particularly excited about would be things that would help advance us as a solutions provider that would bolster our sense, analyze, and act value propositions, also opportunities to strengthen or augment our position in near adjacencies, which will be – Xplore will be a casing point.

So, for us, M&A is a vector of growth, but we will always start with looking at the highest risk-adjusted return for our investors.

[Jim Ricchiuti, Needham & Company, LLC]

Thanks very much.

[Operator]

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

[Keith Housum, Northcoast Research Partners LLC]

Good morning, gentlemen. Congratulations on a good quarter. Anders, last quarter, I think you guys offered a little bit commentary that the pipeline into large deals for the rest of the year just wasn't that great. Not that we weren't there, but you just didn't have a great pipeline to it. Did things change over the quarter that the large deal pipeline just seems to grow or you (25:49) have more visibility there?

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. I'll start and then, I'll have Joe Heel help out here also. But, yeah, when we started the year, I think we had limited visibility to larger deals and larger pipelines. That has – we put a lot of emphasis on both driving our run rate business, which has also been growing very nicely over the year here, as well as making sure that we paid attention to larger customers and that we could win new refreshes or new deployments with them. And I'd say over the last three, four months, we've seen a meaningful improvement, the strengthening of the large deal pipeline also. And that's reflected in our Q3 guidance.

Joe?

[Joachim Heel, Zebra Technologies Corp.]

Not much to add. I think we have been pleasantly surprised by the ongoing momentum in terms of the conversion of Windows to Android, not only in retail, but as we mentioned earlier also in other segments like T&L. And we have seen an ongoing trend by our customers to make those transitions and the visibility we've gotten into those transitions has given us both very good results in Q2 and the confidence for some of our outlook that we've shared.

[Keith Housum, Northcoast Research Partners LLC]

Great. I appreciate the color. I guess a brief follow-up if I can. R&D went up by about $10 million this quarter. I guess Olivier or Anders, can you just talk about the strategy for R&D going forward? And what does the growth that you are having now, what does that give you the ability to invest in it perhaps you weren't able to invest in before?

[Olivier Leonetti, Zebra Technologies Corp.]

So, let me answer to the OpEx trend in general rather than only R&D, Keith. So, first of all, you're right, we have increased the OpEx year-on-year by about $20 million. We're investing in organic investments and also in high incentive compensation based upon the performance of the business.

And when we deploy capital in OpEx specifically, we have three key principles in mind. First, we want to scale OpEx as a proportion of revenue. And as you saw in Q2, we have increased OpEx as a proportion of revenue by 140 basis point year-on-year. We had the same kind of scaling last year. So, principle number one.

Principle number two, we want to be prudent in the way we invest and we want to generate, obviously, profitable growth and we have been able to do that nicely over the last two years, Q2 being not an exception. And we also invest in a viable cost, we want to be able to nimble.

And maybe, Anders, you have other points to add.

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. Just briefly, I'd say we have lots of very attractive investment opportunities across all our product portfolios. And we have a productivity program going on to help make sure that we free up as much investment capacity as we can to put that money to use in a most productive way. So, product development and sales and marketing are the three areas that tend to get the most of that, but also some of that we let flow through to shareholders to make sure we have a good balance. But we have lots of good opportunities for investment that will drive growth for 2019 and beyond.

[Keith Housum, Northcoast Research Partners LLC]

Great. Thank you very much.

[Operator]

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

[Jason A. Rodgers, Great Lakes Review]

Yes. Just wanted to talk a little bit about the AIT segment. You had very strong organic growth there versus what you've done in previous quarters. You mentioned the benefits from new products, but I was wondering if there are any especially large deals that contributed to that growth and how sustainable that growth may be in the second half.

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. First, we're driving growth across all our business segments now or product segments now and I'd say our innovative and broad portfolio product solutions is a major differentiator and strong driver for us. Also our deep understanding of the vertical workflows within our customers' operations is helping us be much more of a partner to our customers. And we're excited about all our products here this quarter. We had strong performance across all major product categories.

On the printing side, we saw – AIT had particularly strong performance in North America and in Europe. The new portfolio – the new products we have come out with have performed very well and we have a very strong and fresh and differentiated portfolio of solutions today. Things like Link-OS provides an unrivaled manageability of our printers that is very difficult for others to emulate. You can now scrape off data from labels and use that as intelligence – or to drive intelligence, you could say.

Our desktop and mobile printers did very well in Q2. We also launched a new card printer in the second quarter, one of our entry-level models, which was performing very well and got very good feedback from customers.

Supplies we think of as a very attractive business, but it is an underpenetrated market from Zebra's perspective and we believe we have good opportunities to continue to grow there also. And overall, I'd say our printing and supplies business were the biggest beneficiaries of One Zebra of the combination of the traditional printing business with the enterprise business.

And let's see if Joe has anything to add.

[Joachim Heel, Zebra Technologies Corp.]

Well, perhaps only on your specific question around large deals, I would say there isn't a single large deal or a grouping of large deals that has influenced our results in Q2 that we share disproportionately. We did have a number of areas that had very nice growth. For example, the manufacturing in Asia, which is one of our big customers, as Anders mentioned, healthcare where we do have a strong presence with printers and supplies, all have contributed very nicely with growth, but not in any one concentrated deal or group of deals.

[Jason A. Rodgers, Great Lakes Review]

And then, as a follow-up, with debt no longer the priority for cash flow, just looking specifically at share repurchase, should we expect that to at least offset the future dilution? And also, I wanted to get your thoughts on initiating a dividend.

[Olivier Leonetti, Zebra Technologies Corp.]

So, as Anders indicated, we are very excited by the end-markets we are serving and by the competitive position of the company. And our first order of priority is going to be to invest in our business organically or inorganically. And we think that is the best way today to deliver good return for our shareholders. Now, buyback and dividends are not off the table. We will evaluate all our options. But first order of priority is going to be organic and inorganic investment opportunities.

[Jason A. Rodgers, Great Lakes Review]

Thank you.

[Operator]

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

[Joe Aiken, William Blair]

Thanks. This is actually Joe Aiken on for Brian this morning. I was wondering if you could talk a little bit about the winding down of 3G and how large an impact that could have on the business looking ahead to 2020 or 2021 and beyond and more specifically with the transition away from Windows taking place, won't most devices already be compatible with 4G or LTE by that time?

[Anders Gustafsson, Zebra Technologies Corp.]

Yes. The first, the transition from the Windows to Android, that continues to be a key driver of growth for us. We are approaching 50% market share overall for our mobile computing platform or portfolio and our market share for Android is substantially higher than that. So, that's a driver for our market share increases.

We see continued good potential for continued growth in Android. There's still, we estimate, at least 10 million legacy Windows devices out there that remains to be updated or refreshed to Android. And we now see continued expansion of the vertical markets or the use cases where Android is being used. So, started off in retail, transportation logistics is clearly helping now. Healthcare is doing well.

And we see Android having a somewhat shorter lifecycle than Microsoft devices. So, that will also be a help. Specifically, for 3G, so for those who aren't as familiar maybe with 3G, that's – as the service providers in North America will start rolling out 5G, they will have to do some frequency reharvesting and the 3G service will be turned down over the next, I can't remember, I think it's 2021 is the end date for when 3G service will disappear.

And we have and the industry has a number of 3G-only devices, Wide Area Net devices in service today and those obviously will not work on the 4G network. So, we think there's probably about maybe 3 million devices or so in the market from us and others that would need to be refreshed as part of that upgrade also.

[Joe Aiken, William Blair]

Great. Thank you. And then just a follow-up, can you give any more granularity around the software and service segment, specifically what percent of sale the software account for in that and what was the growth of each during the quarter, if you can?

[Olivier Leonetti, Zebra Technologies Corp.]

Of course. So, services and software represent about 10%, a bit more of the company revenue. And the growth has been in the mid-single digits. We are pleased with the performance of this particular segment. It has been an area of focus for us. The first order of priority was over the last few quarters to raise customer satisfaction and as a result, we in-sourced North America operations. We in-sourced that in the U.S. and we have seen, as a result, as indicated, sales benefiting from that transition. So, we are pleased with the result and we think that this is actually the start of a new trend for us.

[Anders Gustafsson, Zebra Technologies Corp.]

Maybe two things I would add is the segment that you referred to also includes professional services and software. And we see those as critical to the EAI solutions that we're bringing to market and they are enabling those very nicely.

[Joe Aiken, William Blair]

Great. Thanks for the color there. I appreciate you taking my questions.

[Operator]

Our next question comes from Richard Eastman of Baird. Please go ahead.

[Richard C. Eastman, Robert W. Baird & Co., Inc.]

Yes. Good morning. Perhaps, Anders, could you just kind of speak to the second half sales outlook, whether it'd be the third quarter and certainly the implied fourth quarter and full year? I'm curious we're now talking about full-year core growth of 8% to 10%, I think, is how the math works out. Could you just zero us in a little bit on where that increased confidence is driven either by end-market, is there – again, we talked a little bit about large deals in the retail segment, but I'm curious, is there any cyclical uptick – you mentioned manufacturing, but maybe just zero us in a little bit on where the increased confidence is over the second half either by end market or perhaps by geography?

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. I think, firstly, we are forecasting now 8% to 10% organic growth. We think that's a prudent forecast based on the visibility that we have today. And I'd say the growth we are seeing now is very broad-based. Right? You see in Q2, three out of four regions had solid growth, all our product categories had good growth. So, we expect to see continued growth from our channel and we had good visibility now also into a large deal pipeline that we'll convert, we believe, in the second half of 2018.

I would say the drivers for this are similar to what we talked about before on the vertical side – within each vertical market. So, in retail, you have the shift to e-commerce and omni-channel. That's a big investment that I would say pretty much every brick-and-mortar retailer and e-commerce provider is embracing and they are adopting our type of technology to be able to execute on those strategies.

We also are seeing some of the newer technologies around RFID or smart infrastructures like SmartLens to help drive growth there. And similarly in healthcare, the continued efforts to digitize healthcare, so going from having a manila folder with hand-scribbled notes to electronic medical records, where you can now type patient data directly in real-time, say, to – from reading something about a customer, client or that – into those records. And the value proposition in healthcare is very compelling for us around stronger care, better care, but also more – better efficiencies which is our normal value proposition.

We talked earlier about transportation and logistics with some strong secular trends supporting growth around e-commerce and on-demand economy. And manufacturing similarly is a big opportunity for us as they've been the slowest so far to convert into Android.

So, we see growth across all the verticals, all the products and, graphically, we continue to see all regions expecting to grow in the second half. Asia Pac, we talked quite a bit about in the prior year. We put a lot of emphasis on Asia Pac and Asia Pac is now delivering very strong growth and I would expect Asia to be the fastest-growing market for us for the foreseeable future.

[Richard C. Eastman, Robert W. Baird & Co., Inc.]

Okay.

[Joachim Heel, Zebra Technologies Corp.]

Let me give you two other data points underpinning our confidence for the second half. One is we look very carefully at a business that we transact in small sizes, what we call run rate business, and we have seen a good and steady growth of that run rate business in Q2 and we see that continuing. That's quite predictable into the second half. So, that underpins our confidence.

And the second is we've talked about visibility to large deals. And we were, of course, particularly prudent about our second half, because, as you remember, last year in the second half, we did have a good number of such large deals and we wanted to make sure that we can repeat that. And we do have good visibility to large deals in the second half. So, those two data points, in particular, would underpin our confidence.

[Richard C. Eastman, Robert W. Baird & Co., Inc.]

Great. And then, just as a follow-up question, Anders, should we be concerned or thinking about any tariff-related issues on Zebra, whether it'd be on the cost side or just on the demand side? Anything to think about there?

[Anders Gustafsson, Zebra Technologies Corp.]

I'll let Olivier start.

[Olivier Leonetti, Zebra Technologies Corp.]

Yeah. So, this is a dynamic environment and we don't know what would be ultimately enacted and it would be premature to speculate on the call. The tariffs, which have been enacted to-date, the minimal impact on the company, they're included in our guide. And, going forward, we are looking at all options today and our objective will be to minimize the impact of those tariffs on the P&L of the company. And we have a flexible supply chain, which will allow us to achieve that over time.

Maybe, Anders, you have additional comments?

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. Maybe a couple of comments on the demand side there. So, we certainly haven't seen or heard it from customers today that they are concerned about tariff from the demand side. The one mitigating factor for us will be also that we tend to be a smaller part of a large network or a large rollout. So, even if there were to be some impact, modest impact on our solutions, it would not necessarily put the ROI at risk for our customers in a bigger rollout.

[Richard C. Eastman, Robert W. Baird & Co., Inc.]

Okay. Okay. Very good. Well, thank you. Thank you for your time.

[Anders Gustafsson, Zebra Technologies Corp.]

Thank you.

[Operator]

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

[James E. Faucette, Morgan Stanley & Co. LLC]

Thank you very much. I wanted to ask just in terms of your investment, et cetera, should we expect that the impact will be entirely to OpEx as you continue to invest in the business or should we expect that there may be some gross margin impact either as you secure footprint with new big customers or as you introduce new products?

[Anders Gustafsson, Zebra Technologies Corp.]

Do you want?

[Olivier Leonetti, Zebra Technologies Corp.]

Yeah. We have outsourced our supply chain. So, most of the investments we made would be in the OpEx category. But again, we expect, as we have demonstrated, to be able to scale OpEx as a proportion of revenue, James, and the company as the team has done a good job on that particular dimension. So, mainly in OpEx.

[Anders Gustafsson, Zebra Technologies Corp.]

But when we look at where we're making the investments and some of the investments start to show up in OpEx, but we are investing in building capabilities and other ways of reducing the cost of goods sold in our products to make sure that our gross margin can hold up or increase over time.

[James E. Faucette, Morgan Stanley & Co. LLC]

Got it. And then, my other question just related – was related to debt. Obviously, you've done a lot of refinancing there. But given the changing interest rate environment and just what your debt levels are coming down to, is there any incremental that can be done on debt refinancing to further bring down interest rate expense? Thanks.

[Olivier Leonetti, Zebra Technologies Corp.]

We are looking at all opportunities and we are surprised ourselves to keep finding opportunities. We believe we have some additional levers indeed to reduce the debt and would probably deploy those initial odd (45:37) ideas in the coming two to three quarters. But we think we still have opportunities, James.

[James E. Faucette, Morgan Stanley & Co. LLC]

Thank you very much.

[Anders Gustafsson, Zebra Technologies Corp.]

Thank you.

[Operator]

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

[Paul Coster, JPMorgan Securities LLC]

Yeah. Thanks for taking my questions. First up, Anders, I'm wondering if you can hazard a guess of what you think the long-term growth rate is through the cycle now. I mean, what of this is cyclical versus secular?

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. We are always challenging ourselves to think about how can we maximize profitable growth and the 4% to 5% growth target that we've talked about historically, we think is still – is not aspirational and that does not include any acquisitions. So, that will be only on organic growth. And, hopefully, by now, we've proven to everyone that we can execute and that we have over achieved this target since we concluded the acquisition of the Enterprise business back in 2014.

And at this stage, I think we have a very strong competitive position. It's a very diversified business and we have many levers that we can pull to achieve sustainable growth, both in top line and bottom line. We see our core as still having great growth opportunities or near adjacencies and also some of the newer solutions that we have around our Enterprise Asset Intelligence vision. And we are making solid organic investments to drive profitable growth for the business both for 2019 and beyond. So, we feel good about where we are.

[Paul Coster, JPMorgan Securities LLC]

So, Anders, the only thing I'd like to ask about is if you look at the slide 13 of your presentation, enabling enterprise visibility and the strategic objectives here in the four verticals, in every picture there's a human being or a human hand. But as you know, some of the fastest growth we're seeing where the highest multiples being awarded are in machine vision, robotics, where there's no human being involved necessarily. Can you talk to us about those adjacencies? Is that something that you may pursue or whether you are ultimately tied to the human hand essentially here as part of your strategy?

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. I'll start giving you a little bit of a sense of our EAI strategy and then how that plays into automation. But, first, we continue to be very excited about our EAI vision and where we think that can take us and the growth opportunities we can see there. It resonates very well today with our customers and our employees and it's very much integral to everything we do in the company. Our sense, analyze, and act framework is a great way for us to think about this that helps drive real-time guidance at the edge of the enterprise for our customers.

We help our customers digitize their businesses through a variety of way or such (48:47) – Link-OS on the printing side, Location Solutions, our various Smartx type of solutions. And it also helps us – helps position Zebra as a thought leader. We had a great win last week actually with an important customer, competitive takeaway, where I think the thought-leader status that we had was a big part of why we won that business. They thought of us as somebody who could help them beyond just the RFQ that was out, but more deliver innovative solutions to them over the next several years. So, overall, with EAI, we're very pleased with progress and it gives us a number of attractive horizons for growth.

If you then move into more the automation or intelligent automation as we call it, we think of that as a big net opportunity for Zebra. It's kind of a natural extension to our EAI strategy. We leverage the same kind of critical capabilities for automation as we do for EAI. And when we look at the – we see opportunities to help automate basically each of the steps, the sense, analyze, and act steps, that we have, right?

And when people hear automation first, I think many people's minds go to robotics. I think that's one way of delivering that automation, but a lot of it is around how to automate the data capture, the analytics and how to dispatch that action to the right person and that might be a person or a robot of some sort, right?

So, what we do is we help solve our customers' problems and we do that by leveraging how to make humans more efficient and effective. We leverage robots where appropriately and we have smart infrastructures that provide even higher level of, say, automation.

So, I think of automation again as a continuum. You can possibly think of a specific use case like inventory or replenishment in a retail store. Historically, it started with a human going out and counting whatever was on the shelves and having a clipboard to write down what was there.

Then, with barcodes, you could start automating and making those humans more productive by scanning that barcode. Then, you can see with introducing robotics that you can have a robot that can go up and down the aisle and be able to read the labels on the shelf and see also how many units of something is on the shelf. They can see if there's any gaps and they can take action on those things. Or we have drones as another kind of robotic activity where we've seen system integrators take our – four of our long-range scanners to put on a location solution tag to enable to guide and control the drone and basically control it from one of our tablets.

So, we're very much involved also on the robotic automation side, but we think maybe that the smart infrastructure is the more enabling, the bigger opportunity for automation. If you look at SmartLens, SmartPack, SmartFreight, all of these things where you have a system that is situationally aware, can know in real time exactly what's on the shelves, it can automate that data capture, it can automate the analytics of being able to determine that you're running low on a certain piece of merchandise and you can automatically send an action to a person or to a, say, robot to replenish that good.

So, for us, I see it as a big net opportunity and we're looking to see how we can kind of participate across that continuum of both augmenting humans to be more productive, but also taking advantage of smart infrastructures and other tools that can deliver those improvements.

Does that answer your question?

[Paul Coster, JPMorgan Securities LLC]

Yeah. It does. So, I mean in the future, it need not have a human being in the picture is the way I inferred that. And so, there's nothing out of scope. All right. Got it. Thank you.

[Anders Gustafsson, Zebra Technologies Corp.]

Yeah. Yeah.

[Operator]

This concludes our question-and-answer session. I'd now like to turn the conference back over to Mr. Gustafsson for any closing remarks.

[Anders Gustafsson, Zebra Technologies Corp.]

Thank you. As we wrap up, I want to thank the Zebra team and our partners for another quarter of strong growth and strong results. And we look forward to welcoming the Xplore team once we close the transaction. So, have a great day, everyone.

[Operator]

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