斑馬技術公司 (ZBRA) 2017 Q2 法說會逐字稿

Good day, and welcome to the Second Quarter 2017 Zebra Technologies Earnings Release Conference Call. (Operator Instructions) Please note, this event is being recorded.

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

Good morning, and thank you for joining us. Today's conference call and slide 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 highlights and key drivers of the results. Olivier will then provide more detail on the financials and discuss our third quarter and full year outlook. Anders will conclude with discussion of recent progress made on Zebra strategic priorities. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. This presentation is being simulcast on our website at investors.zebra.com, and will be archived there for at least 1 year.

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 the slide presentation.

Also, as a reminder, our reported financial results include the divested wireless LAN business through October 2016. In this presentation, our references to sales growth are year-over-year on a constant currency basis and exclude wireless LAN sales from 2016 results.

Now I'll turn the call over to Anders.

Thank you, Mike. Good morning, everyone, and thank you for joining us. We had another successful quarter executing on our strategy. As you see on Slide 4, our team delivered solid second quarter results, including adjusted net sales of $897 million, with organic growth of greater than 6%, which exceeded our guidance range. Adjusted EBITDA margin of 17.7%, reflecting a 140 basis point improvement over the prior year. Non-GAAP EPS of $1.51, a 29% increase over Q2 of last year and $160 million of debt pay down, driven by strong free cash flow and prudent cash management. We accomplished all of this while successfully implementing the last major milestone of the enterprise integration by going live with our global ERP system. This represents the culmination of 2.5 years of dedication and focus by the entire team and completes our transition to One Zebra.

Now turning to the quarterly results. We achieved growth across all regions led by double-digit growth in Latin America and 9% growth in North America, driven by high demand for our Android enterprise mobile computing portfolio. In the quarter, we continued to extend our market leadership and delivered innovative solutions to our customers that provide them increased visibility into their operations. We enjoyed significant wins, including many large orders for a wide range of our mobile computers and saw especially strong demand from our retail and transportation and logistics customers. Delivering strong results for the past 2 quarters gives us the confidence to narrow the range of our full year sales outlook to the top end of our prior guidance. In addition, our recently announced comprehensive debt restructuring lowers interest rates and drives profitability improvement.

With that, I will now turn the call over to Olivier to review our financial results in greater detail and to discuss our debt restructuring and 2017 outlook.

Thank you, Anders. Before we get started, I would like to remind you that references to sales growth are year-over-year on a constant currency basis and exclude wireless LAN from 2016 sales results.

Let us begin with a walk through the P&L. As you can see on Slide 5, adjusted net sales for the second quarter were $897 million, up 6.4%. Our second quarter sales performance was driven by solid results in each of our reporting segments and growth across all of our regions.

Enterprise segment sales of $584 million increased 7.9%, driven by double-digit growth in mobile computing. Pre-transaction Zebra sales were $313 million, up 3.7%. Printing and supplies sales were higher as were sales in our location solutions business. Sales of services were approximately flat.

Turning to our regions. Sales growth in North America was up 9%, driven by strength in mobile computing. We add another strong quarter in retail and e-commerce as the industry continues to transform to meet evolving consumer purchasing preferences. EMEA sales increased 4% from a year ago. We are seeing broad-based traction and solid demand for our offerings across the region.

Latin America sales increased 11%. We saw exceptionally strong sales in data capture, printing and supplies across the region.

Sales in Asia Pacific were up 2%, where we are cycling strong results in the first half of 2016. Current year sales were positively impacted by 3 percentage points related to the release of reserve for price concessions related to duties previously imposed on printers in China.

Most of the region grew with particular strength in Australia. China was the exception, where we are experiencing softness in the data capture and printing markets. China accounts for less than 1/2 of Asia Pacific region sales, and we continue to view it as a long-term growth driver of our business. Our team has a comprehensive go-to-market improvement plan to strengthen results, including enhanced product offerings.

Consolidated adjusted gross margin of 46% was 40 basis points lower than the prior year period, primarily due to changes in business mix, driven by the exceptionally strong quarter in mobile computing.

Gross profit increased $4 million from the prior period due to higher sales volumes. Adjusted operating expenses in Q2 were $274 million, down from $282 million last year. These results primarily reflect the company's continued focus on improving operating efficiency, controlling expenses and the divestiture of the wireless LAN business.

Second quarter 2017 adjusted EBITDA margin was 17.7%, a 140 basis point increase from the prior year period. This was driven by higher gross profit and lower operating expense. Non-GAAP earnings per diluted share increased to $1.51 in the second quarter, an increase of 29% from the prior year period. Lower interest cost and the lower tax rate also contributed to the sharp increase in EPS.

Integration expenses were $19 million in Q2, a $15 million decrease from the prior year period. As Anders mentioned, we exited all remaining transition service agreements with Motorola Solutions in early Q3. We expect minimal integration expense in the second half of 2017.

Turning now to the balance sheet and cash flow highlights on Slide 6. We ended the second quarter with $95 million in cash. Our transition to a single global ERP system has enabled us to pool operating cash more efficiently and significantly lower our cash balances. As of the end of the second quarter, we add $2.4 billion of long-term debt on the balance sheet. We paid down $160 million of principal under Term Loan B in the quarter, driven by strong free cash flow and reduced cash balances. Free cash flow of $77 million increased by $65 million compared to the second quarter of last year, primarily due to increased profitability, improved working capital management and lower capital expenditures.

Slide 7 shows our path to financial deleveraging. The top priority for cash flow and excess cash balances is to aggressively pay down acquisition debt. Our net debt to adjusted EBITDA ratio decreased to approximately 3.6x as of the end of the second quarter, which is down from more than 5x as of the close of the Enterprise acquisition in late 2014. Our profitable growth and strong free cash flow profile continue to provide us confidence in achieving a debt leverage ratio of less than 3x by mid-2018.

Turning to Slide 8. On July 26, we announced a comprehensive debt restructuring. We're taking advantage of a favorable credit market to reduce our average interest rate by approximately 2 percentage points and drive more than $45 million of annual interest savings. We closed on a senior secured credit facility maturing in 2021, initially priced at LIBOR plus 2% with the opportunity for reduced pricing as we approach our debt leverage target next year. This facility includes a $688 million Term Loan A and a $500 million revolving credit facility. Yesterday, proceeds from the new facility were used to redeem $750 million of our 7.25% senior notes, maturing October 2022. We plan to redeem the remaining $300 million of the senior notes in the fourth quarter through lower cost financing arrangements, including an accounts receivable securitization facility. We also amended $1.3 billion Term Loan B facility, maturing October 2021, reducing the interest rate by 50 basis point to LIBOR plus 2%. As a result of the debt restructuring plan, we expect to pay a total of $72 million of redemption cost and transaction fees in the second half of the year, of which we expect to pay $55 million in the third quarter.

We also expect to incur approximately $18 million of noncash accelerated amortization of debt issuance cost and discounts in the second half of the year, of which we expect to record $13 million in the third quarter.

On Slide 9, you will see that for the third quarter of 2017, we expect the change in adjusted net sales to be between negative 1% and positive 2% on a nominal basis. We expect organic net sales growth between 2% and 5%, with growth in all major product lines. This growth expectation excludes the adverse impact of 4 percentage point from wireless LAN and a 1 percentage point positive impact from foreign currency translation. Given the recent weakening of the U.S. dollar, foreign currency impacts are expected to be accretive to us in the second half of the year.

We expect sales growth to moderate through the balance of 2017, considering the more challenging year-over-year comparisons and the lumpy nature of our business. Third quarter 2017 adjusted EBITDA margin is expected to be in the range of 18% to 19%, an increase from the prior year period. This rate assumes higher gross margin as compared to the prior year period.

Additionally, we expect adjusted operating expenses to be approximately in line with the prior year period as a percentage of sales. Non-GAAP diluted EPS is expected to be in the range of $1.65 to $1.85. Given our strong first half sales performance and backlog entering our third quarter, we are narrowing the range of our full year sales growth outlook to the top end of our prior year outlook. We now expect approximately 3% to 6% organic sales growth. This outlook excludes the adverse impact of 3 percentage points from wireless LAN and assumes minimal foreign currency impact. Full year 2017 adjusted EBITDA margin is expected to be in the range of 18% to 19%, which is higher than 2016. Our full year outlook assumes a slightly higher gross margin rate compared to last year and lower adjusted operating expenses as a percentage of sales due to productivity improvements.

For the full year 2017, we continue to expect debt paydown to exceed free cash flow. Our goal is to pay down at least $300 million of debt, which is supported by higher EBITDA, lower integration expenses, solid working capital management as well as reduced cash on hand required to operate the business. We are reiterating this debt pay-down goal despite our expectation of paying $72 million of redemption and transaction fees related to our debt restructuring plan.

You can see other full year 2017 modeling assumptions on Slide 9. Note that we have revised our interest expense assumption due to the impacts of the debt restructuring. Interest expense is now expected to be approximately $235 million to $240 million. This includes redemption costs, transaction fees and noncash amortization.

With that, I will turn the call back to Anders.

Thank you, Olivier. Overall, we are pleased with the progress made on our strategy in the second quarter and our momentum as we enter the back half of 2017.

As you see on Slide 10, we are focused on several areas to build upon our leading positions globally and to drive profitable growth. First, we are leveraging our scale, innovation and relationships with customers and partners to extend our leadership with an innovative portfolio of enterprise visibility solutions. Second, we are advancing our vision of Enterprise Asset Intelligence, or EAI, by leveraging Zebra's deep knowledge of the markets we serve and capitalizing on key technology trends. I will update you on our progress in a moment. Third, we have achieved the final milestones of the Enterprise integration. In May, we went live with our global ERP and IT ecosystem. Since that time, we have been stabilizing the combined platform, and we have recently exited all remaining transition service agreements with Motorola Solutions. We now have the opportunity to further increase productivity across the Enterprise and improve the experience for our partners and customers. Our fourth area of focus is to further enhance Zebra's financial strength by increasing profitability, improving cash flow and optimizing our capital structure. We are driving profitable sales growth, and our cash flow profile continues to improve. Our recently announced debt restructuring significantly lowers our interest costs and provides the flexibility to delever our business to achieve optimal levels.

Now turning to Slide 11. Zebra is uniquely positioned to capitalize on key megatrends in mobility, cloud computing and the proliferation of smart devices through our technology, which sends us information from all enterprise assets. Data from these assets, including status, location, utilization and preferences is then analyzed to provide actionable insights in real-time. This EAI framework provides additional view of the entire enterprise, which enables visibility for our customers into their business operations and workflows, resulting in smarter business decisions.

Zebra brings this vision to our customers through our broad innovative portfolio of solutions, including enterprise-grade mobile computers, printers, scanners as well as intelligent infrastructures, software and services. We are also committed to empower our global partner community so that they can deliver our new EAI data-driven offerings as well as their own to the market. We will continue to provide the resources and tools necessary to help them succeed in delivering innovative EAI solutions to the end user.

Slide 12 highlights how we serve our key vertical markets. The trends our customers are seeing in the marketplace are driving opportunities for growth at Zebra. Consumers now expect retailers to provide them goods when and how they want it delivered. Transportation companies to deliver in hours rather than days and health care providers to administer a higher quality of care at a lower cost. Additionally, manufacturers are focused on shortening production cycles and reducing waste with a more mobile workforce.

Zebra has a deep and intimate understanding of the operational workflows in the key industries that we serve. Our expertise enables us to help our customers navigate the changes in their business. In retail for instance, we continue to play a leading role in helping companies execute their e-commerce strategies through our broad range of solutions. We are seeing strong demand from the largest e-commerce players in the world for our warehouse-grade mobile computers, hands-free ring scanners and mobile printers. They utilize our solutions to enhance their speed and efficiency. Additionally, e-commerce workflows are tracking-intensive and accuracy is paramount to successful execution. Our solutions reduce errors and minimize returns, which are costly to service and a hassle for customers. We are also driving innovation in the front of the store with our personal shopper mobile computers. Recently, a leading European grocery chain implemented this solution to revolutionize the store experience by allowing shoppers to scan their own items as they shop. This allows their customers to control the store experience as well as check out faster. This solution also provides real-time visibility into their shopping trip, which allows the grocer to send relevant promotions and suggestions for complementary items directly to the mobile computer, increasing basket size and loyalty. Store staff utilize the same device for store audits, price checks and inventory management, which further improves productivity.

In the transportation and logistics space, we recently expanded our relationship with a global food service distributor. As part of their warehouse delivery and modernization effort, this customer has been implementing our solutions for a variety of workflows and processes. These include forklift-mounted and handheld mobile computers, ring scanners and mobile printers used for restocking and picking items in the warehouse, including in the freezer. This customer is also upgrading to our recently launched Android mobile computers for thousands of delivery trucks and to execute on their new proof of delivery process. This relationship highlights the power of One Zebra and our comprehensive set of enterprise devices and services.

In the manufacturing and industrial space, we recently rolled out our next generation industrial thermal printers, which are both intelligent and engineered to withstand the years of continuous operation in harsh production environments. This cloud-accessible Link-OS operating system enables user-friendly remote routing, configuration and firmware updates. These printers also have a flexible design for hardware upgrades in the field, including the ability to print RFID labels.

In our health care vertical, we are excited to announce our collaboration with GE Health Care on a solution that enables hospitals to accurately manage inventory, reduce total cost of ownership and achieve improved capital allocation. Health care providers are able to locate mobile assets in real-time so that they can spend less time searching for critical equipment and more time focused on quality patient care. Historically, it had been expensive and time-consuming to implement a hardwired solution.

Our new innovative solution is flexible, built upon commercial Bluetooth technology and leverages the hospital's existing WiFi network. The solution only takes days to implement and is accessible to any staff member with a mobile device. With Zebra's expertise, asset and operational activities can be analyzed so that the right decisions can be made in real-time.

Finally, across all our verticals, we continue to see traction in our visibility services that provide insight into the status, location, usage, health and overall activity of the Zebra fleet of deployed mobile computers and printers. This device visibility is becoming increasingly important to our customers as they seek to further optimize their workforce productivity.

In closing, we will continue to work with our customers and partners to drive digital transformation forward, equipping companies of all sizes with data-driven intelligence to improve their operations. I would like to thank the entire Zebra team for their dedication and focus on our priorities. We have successfully executed on a comprehensive acquisition integration program, and we continue to meet our growth and profitability objectives.

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

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

(Operator Instructions) The first question comes from Paul Coster with JPMorgan.

Congratulations on getting off those TSAs. And with which, maybe Olivier, can you talk about synergies? Are they completely played out now? Or they even more to come now that you've got the ERP here. And then presumably you're still kind of road testing it?

Paul, we believe that after the successful implementation of our ERP that we have the opportunity to drive synergies further. It's to large extent, actually, reflected in our EBITDA margin, Paul.

Okay. That's the outlook, right? And are the synergies going to be played out completely by year-end? Or do you see this as a process that extends into 2018?

We think that this is going to be an ongoing process. You will start to see the benefit of those productivity initiatives in the second half of this calendar year. And more will come next year as well.

Anders, I know that you don't have that much visibility, but can you comment on pipeline backlog and bookings momentum going into 3Q?

Yes. We are confident in our outlook for the third quarter. We entered the quarter with good backlog and solid momentum. I think we're very well positioned for growth across the business. We have a very strong portfolio of solutions today. And we also have our Enterprise Asset Intelligence, new type of solution site, and that's providing great thought leadership for us in the market. So for Q3, we expect growth across all our product lines.

And to wrap, do you feel like things have changed at all, has the macro environment getting incrementally better? Or is the understanding of your technology improving? Is your portfolio now hitting sweet spots that it previously wasn't? Anything that kind of gives us a sense of what's changing here, if anything?

I think the -- yes, a lot of things. I think we know -- we're benefiting from a, I think, improved macroeconomic environment. But also we have, I would say, that maybe the 2 things to highlight here for Q2 and looking at Q3, one will be, we believe our product portfolio is as competitive today as it has probably been ever across the board. We have mobile computing with our Android, all touch devices. We have a refreshed data capture portfolio, and we have a lot of new printer products that came out, particularly the high end here recently. So I think we have a strong competitive position with our products. And we've seen particularly strong larger deal activity from our retail and e-commerce customers where we are helping them capitalize on the shift from e-commerce -- from, say, traditional retail to e-commerce and omni-channel. And we're moving from having been viewed more as a tactical productivity tool to more of a strategic enabler, somebody who can help them execute on their strategies. And some of our new solutions like SmartLens clearly demonstrates how we can do some of those things and positions us to be a real thought leader in the industry.

Paul, an additional comment. We have been able to compete very well up to now, despite having to manage successfully a very complex integration. So a big change now is going to be -- that we are going to be fully dedicated to externally and fully dedicated to compete in the market, Paul.

The next question comes from Matt Cabral with Goldman Sachs.

You've talked a lot about the strength in retail over the past few quarters. So I have 2 questions around that, and I guess, I'll just ask both at the same time. The first, this relates a little bit to your last answer, Anders, but it feels like we've heard about the benefits of omni-channel for several years now. But why is it do you think that customers are now finally starting to make those investments? What's been the major catalyst that you've seen? And then the second question I have is just around the competitive environment that you're facing. And if the landscape really changes at all, is these retailers are starting to make more transformational in next generation investments.

So first, your question was around why are retailers getting on with omni-channel today. Yes, it's fair to say that this is not a necessarily a new concept. But I think that there is a few things that have changed in the -- say, in the background to enable this to happen. One is that it requires substantial investments across other things like the ERP systems and other things that needs to be put in place to be able to execute on that in the first place. So our technology is not the only technology required for this, but it is an essential part of what's required. And I think retailers have been positioning themselves for this -- for -- to be able to execute on omni-channel for some time. And today, but I think there is -- by and large, omni-channel would be 1 of the top 2, 3 priorities for most of our brick-and-mortar customers. So it is something that is going to top of mind for them. So that would be your first question. On the competitive landscape, I'd say, we've always been operating in very attractive markets, strong growth markets, but -- and that have strong secular growth trends behind them. Our EAI strategy, I think, resonates very well with our customers and expands our, say, our footprint. Our team is executing very well on that and expanding our leadership position. All the while, we've been also completing the very complex integration. So from a Zebra perspective, we are very much focused on driving profitable share gains. We want to leverage our unmatched portfolio of new product and our vertical expertise to deliver these new innovative solutions, both devices and solutions like SmartLens, which address some very substantial market opportunities. We also look at our global channel partner program as a competitive advantage for us. But our environment continues to be a very competitive environment. And there is some -- as we talked about earlier, some pockets of promotional activity. But we have a very disciplined yet, I would say, flexible approach to how to deal with that.

This is Joe Heel. One thing I would add is, this -- the transition in retail, it was at the core of your first question, is also coming at the very time that the technology that we are offering and that the retailers are deploying is changing to Android-based environments, which both offers the retailers new functionalities, but it also is a compelling reason for them to transition at this particular time to embrace that new operating system environment.

Next question comes from Jason Rodgers with Great Lakes Review.

I was wondering if you could provide more detail around the retail vertical performance in the quarter? Just looking at the online versus brick-and-mortar.

Yes. I touched on that on my -- under prior questions here. So it was a very strong performance for us in retail and -- both traditional brick-and-mortar and e-commerce was a strong vertical for us in Q2. We've seen our new, particularly Android-based all-touch devices have great traction in that market. It's -- our market share in retail for Android devices is very high. Overall, in total, I'd say, our Android all-touch devices have over 50% share of the market. And the -- I would say, also here, the retail or omni-channel type and e-commerce type of opportunities started off as being primarily in North America and maybe Western Europe. We're starting those to become much -- see those opportunities go global. So this past quarter, we had great opportunities in Australia, even in China. So it's becoming much more of a global opportunity for us.

Maybe 2 other characterizations I would add is that the retailers tend to have a purchasing behavior where large refreshes are done in -- at one time. And certainly in the second quarter, several of these very large refreshes have occurred and have driven a large part of the retail business. The second thing, I think, we were undoubtedly seeing is that we are moving our position with the retailers from being a productivity tool to being more of a strategic enabler. If you look at the agendas that they are pursuing, the offerings that we have are central to some of the transformations that they are trying to accomplish, for example, around omni-channel. And one example that I would give you is the offering which we released at NRS, called SmartLens, which we think is a true demonstration of industry leadership of how workflows and operations in retail can transform with the help of the technology we're offering.

And wonder if you could just talk a little bit more about the softness in China if that was due to competitive factors and some detail on some your plans to improve results there?

Yes. China has always been a competitive market, and it's a very important market for Zebra where we have a strong position. So we have been working on developing some comprehensive go-to-market plans to strengthen our position there. And we're also -- we will also be introducing some new enhanced product offerings over the next several quarters to help grow our business further. And outside the early signs of our go-to-market plans -- the implementation of our go-to-market plans has been very encouraging.

Yes. I think the other thing to note is, as we're looking at China, in particular, we are cycling a prior year that was extremely strong, right? We had double-digit growth in the first half of the last year in China. And this year, we have that compare to deal with. That said, as Anders mentioned, we have some aggressive plans underway to build on that further, and we're quite confident that we're on the right path with that.

Then finally, why was services flat for the quarter? And just looking at your Zebra OneCare offering, how many mobile devices do you currently have under management?

So we don't have -- I can't give you the exact number of devices we have under management. But let me talk more generally about services. We have -- we actually have a strong momentum in services around our managed services, and in particular, the visibility services that we offer. And we are continuing to invest in that space. We think this is -- service is a great add-on to our portfolio. And it supports our Enterprise Asset Intelligence vision. And the other thing that's important to us about services is that we have been able to continuously improve our margins, and we expect that to continue also.

The next question comes from Jim Ricchiuti with Needham & Company.

It is maybe related in part to the last question. But I'm just looking at the -- I'm wondering how we should think about that services and software line looking out over the next 1 to 2 quarters. And there may be some moving parts here. But I'm just curious about the year-over-year decline in the first half of the year.

The services and software line. I think go back to what Joe said. There is -- we certainly have strong momentum around our professional services, our managed services. So that's around our, what we call, OVS or ABS, where that's been -- those types of visibility services have been very much liked by our customers, and we see great demand for those. We can say also, we had less devices to repair in the second quarter, which put a damper on the revenue side, but that's kind of good news, bad news. And we -- as we -- one thing to remember though maybe would be that when we sell a large new mobile computer contract, usually what happens is that, that customer had an existing fleet of devices that were under -- not under warranty, but we were servicing that under a service contract. But in the first year after a refresh, that fleet is now under warranty. So we don't get any service revenue for that.

Got it. Are you guys satisfied with the level of activity you're seeing with respect to the software initiatives?

You can always do better. But we feel that we've been making good progress on software. If you look at, say, OBS, that's a software type of service for us. That's been well ahead of our internal plans. And we have a number of other software initiatives that we're working on. So I think we're doing -- making good progress there.

And software is essential to our Enterprise Asset Intelligence strategy and -- but yet we're being quite strategic with where we invest and then deploy in software because we also have a large partner ecosystem. And our software and the developments we're doing is designed to enhance that partner ecosystem and really support our partners in offering their own capabilities alongside ours. OVS, as Anders mentioned, is a great example of a cloud-deployed software environment that we've invested in that our partners can then build their offerings around. So we're actually quite pleased with how those are being accepted in the marketplace.

And finally, Jim, to conclude, we believe that the service and software lines would grow faster than the company average.

That's helpful. Got it. And final question just on gross margins, product gross margins. Mainly being impacted by mix in terms of the new mobile computing device. How should we think of that product gross margins looking out to the second half of the year? Will we continue to see these trends?

So the answer is yes. And your characterization of the first quarter, Jim, is correct. So based upon the stronger big mix than expected we had in the quarter, our margin was lower. But overall, we ended up with a margin, which is in line with what we would have expected. Our run rate gross margin, which is something we look at very closely, has been strong for period of time and was strong in the quarter. And that's where we have a very strong pricing governance process in the company. And that delivers to -- that allows us to deliver a balanced margin profile. And to answer to your second question, we expect the gross margin -- in second half, the gross margin rate to be indeed stronger.

The next question comes from Richard Eastman with Robert W. Baird.

Anders or maybe Joe, I'll just try to direct your question myself. But at the end of the day, could you just kind of speak to growth in the channel versus the direct business on the mobile computing side? If I look at your Zebra -- legacy Zebra business and the core growth rate there, just 3.5%, 3.7%. Is that indicative of how maybe the channel is performing? And upside to that is on the direct sales at enterprise. Is that a fair way to look at the business or...

I'd characterize it kind of in the following way I think. The run rate business for us is kind of the base on which we work. Then larger deals is we can add on that on top as cream on the cake. So for us, it's absolutely essential that the run rate business performs very strongly. And specifically for mobile computing here, the run rate business was strong. It was actually quite strong, and we're seeing good signs that the Android part of the portfolio is picking up steam in the channel. That's part of the run rate. We have enough volume in the market that the broader ecosystem of partners is picking that up and starting to service those accounts also. So we were actually quite pleased with the performance of the channel for our mobile computers in Q2.

In particular, we have -- of course, the regions are quite different, right, in terms of how we deal with the channels in each of the regions. But to give you one example, in North America, we had a very strong share in the distribution for our mobile computers and across our portfolio. So we're quite pleased with how the run rate has developed in North American distribution to give you one example.

Okay. And then just a follow-up question on -- the other end markets logistics you mentioned was especially strong. Maybe is that a mobile computing-driven end market? And then also, could you just touch on industrial and health care and just how they performed, up or down? And any momentum there?

Yes. Transportation logistics, we're just started with. I think it was a good quarter for us where that -- it continues to be very strong vertical for us with some very strong secular growth trends that's kind of fueling that growth, not least done part of the shift to e-commerce and much more parcel delivery that's going out. So for us, T&L for the last several quarters, have seen good growth. And we expect it to continue to demonstrate good growth also. We have introduced several new products in the last 2, 3 quarters that are fit very well into the T&L vertical. So both are TC70, 75s as well as the TC51 and 56 are well suited for that vertical and have been well adopted there also. So it's -- T&L is an early adopter and a strong driver of our Android growth also. Within T&L, also we do have some of our newer EAI type solutions like SmartPack, that is both demonstrating some good industry leadership for us, but also have been generating good growth over the last several quarters for us. If you look at health care, that's been our fastest growing vertical over the last several years. The catalyst for that growth has really been focused on the electronic medical health records. So then you'll have an electronic database where you can attach other digital information. Our value proposition in health care is strong. It talks both about how we improve patient care, but also how we lower cost and efficiencies. And for health care, we've -- again, we've seen growth started to happen outside of the U.S. and (inaudible) good health care started off as very much a U.S.-led activity. But in the recent quarters, we've seen good wins in Middle East and other parts of Asia. In the past quarter, we also announced our new relationship with GE Health Care for more flexible and affordable asset tracking solutions and hospitals that's based on our beacon technologies. We also, in the last quarter, introduced some new health care versions of existing products. So we have a TC51 Health Care and a DS8100 Scanner for health care. So the portfolio is more -- getting to be fuller for more specialized devices for health care. And then lastly, manufacturing. I think the driver in manufacturing is going to continue to be greater visibility and mobility solutions. And we -- in Q2, we featured our Network Connect solution at the ProMat Trade Show. That is the solution we developed with Rockwell to get our printers and scanners primarily designed into their ecosystem. I think that's a great offering and very helpful to their customers. And we've seen the pipeline grow for that quite nicely. Maybe lastly, in that vertical, I'd highlight our new top-end tabletop printers, the ZT600 and the ZT500 that we have recently introduced. We expect those to be good drivers for us also in that market.

Okay. I understand. Could I also just ask for one clarification. Olivier, you had mentioned that in the third quarter -- you were talking to the third quarter and you mentioned higher gross margin versus the prior period and also operating expenses in line with the prior year period. Is prior the second quarter? Or is prior the third quarter of '16?

The Q3 of last year, Rich.

The next question comes from Keith Housum with North Coast Research.

If I can just get a little more color, I think, on the comment you made, Olivier, regarding the reserve reversal of, I think, 3% in China. Could you provide a little more color on that? And did that drop straight down through gross margins?

It would impact gross margins for -- on the one-to-one basis. And you will have some dilution on upping as we will increase incentive compensation because of that amount. It would mainly, Keith, flow to the bottom line.

Okay. So the increase of EBITDA guidance that you have for increasing gross margins year-over-year sequentially is going to be an impressive increase in gross margins, correct? Would you take that out of consideration? Or is there any reserve reversal anticipated in the third quarter?

So the impact of the reversal add an impact on the margin and on the operating income. But the rest of the portfolio was also strong. Even if you strip that out, you would see that the performance in the quarter from a margin standpoint or EBITDA standpoint was also strong.

Okay, got it. And then as I look at your guidance, as -- you look over tax guidance you guys are providing, is there any change in that compared to the guidance you gave in the prior quarter? Are you thinking that the tax rate for the year might be a little lower than previous?

We haven't changed the -- our tax guidance. We believe that we should guide in the low to mid-20% range. And I would advise you to take that as a planning and modeling assumption, Keith.

Okay, great. And if I can just sneak one quick one in here. Mobile computers looks like another impressive quarter for you guys. It's been following last quarter's impressive performance. Is there any sense that your refresh cycle is starting in anticipation of the January 2020 end-of-life of the Microsoft operating system?

I think we would characterize it today as we've seen certain verticals being early adopters of Android, and I'd say the 2 to highlight would be the retail -- the postal parts certainly within transportation and logistics then -- but even beyond postal health care certainly also on, but it's a smaller volume, say, than that. But there is some other areas that are not quite as early adopters, and we would expect them to start to deploy more Android-based devices as we go forward here. I'm not sure we want to characterize that -- those verticals or people who haven't yet switched to Android as having huge upgrade cycle before 2020. Although we do expect that the vast majority of these -- our estimate of 13 million Windows devices that are out there in the market will be -- become -- will be upgraded to Android before 2020.

One addition perhaps. I think we've said this in prior calls that in retail in particular, but also more broadly in the market, you have large customers who adopt the technology and lead to individual large purchases. But you also have the channel-based business. And what we've seen is that the large customers have been the early adopters. And so many of the deals that we've seen in particular in Q2 have been of that variety and have benefited us. We still expect that the channel-based business, smaller transactions will catch up and will have an equally high share of Android come into play in the quarters to come. And that will then provide -- drive our business going forward.

Your next question comes from James Faucette with Morgan Stanley.

I just had a couple of follow-up questions to some of the comments that we have already touched on. I guess, the first is, when you look at your mobile computing and the strength that you're beginning to see there, how much of this is coming from either new customers or customers with whom you haven't had much of an engagement versus -- or follow-up to the data capture deal you talked a lot about last year? And then just looking for a little more color on the uptake of software products. I can appreciate how you need to work within and continue to support your borrowers and other partners. But where -- what kinds of products are you seeing the most strength? And how should we expect the capabilities of those to evolve?

So I'll start and maybe Joe can help out here also. So first on mobile computing and the strength we're seeing there, I think your question was about how -- are we attracting a lot of new customers into our portfolio or into our business versus just refreshing with existing ones. And we have a healthy mix of both. But I can say, we have a number of large customers that we had not been -- who had not been using our mobile computers before. So we've definitely seen us being able to expand our share position on the back of our Android portfolio. And our mobile computing market share position today is as strong as it's been in many, many years and particularly based on the Android performance we have. So very good news, I think, across all aspects of how it's helping us drive more business. And as part of that also, we have many examples of how the One Zebra plays out that we can get the good win with new customer for, say, mobile computing. But then we -- on the back of that, we were able to position mobile printing and come in with scanners and so forth. So it can -- we can position the entire portfolio on the back of that. On the software side, I wasn't quite as clear on exactly what the question was, but I'll start and I'll ask Joe to help out here also. But first, as we said, we want to be very careful with software and that we work very closely with our value-added reseller partners. And we don't want to compete with them. We want them to think of us as good partners. We're also partnering with a lot of ISVs, independent software vendors, to ensure that we can include all of their applications into our portfolio of solutions that we can offer. It provides great value for them in getting a greater reach but also enables us to help solve more customer problems. But we have a number of software initiatives going on. I would say the one that probably is the most prominent, maybe, here would be around our services, OVS and AVS. So there, we have a common Zebra platform. Part of that would be our -- set our platform that we talked about some years back that we have used as the core for that. But you also look at things like our Hart Systems solution or Zebra retail solutions. That's a great device-as-a-service or another service offering, but it's based on software applications that we've written to be able to take advantage of that opportunity and deliver that service. So our software solutions tend to be more vertically oriented, specifically focused on how to revolutionize how our customers are deploying to some of their use cases and workflows. Similarly with location solutions, that is a -- largely a software business, which addresses workflows for a lot of our different customers. So I don't know, Joe, if you have any.

Yes. I think perhaps one thing that's helpful in thinking about our software business, basically some interest around there, is to think about 4 different levels at which we are bringing the software to market. The first one that's been out there for some time is where we're augmenting our devices. Those would be things like we write software that makes them easier to deploy into customer environments. We write software that allows you to do a voice communication on a device like our workforce connect client. A second level is that within building platforms that provide functionality over and above the device but using information from the device. What Anders mentioned, our OVS is a cloud-based platform that provides customers visibility into those devices at -- in real-time at any given point in time, and any place. And also provides a great platform for our partners to write applications to so that they can offer their own capabilities. The third level, which is the one we're carefully moving into is the level of applications. So on these platforms, you can now write applications that provide entirely new functionalities. Take for example the SmartLens platform that allows a retailer to have visibility to all of their inventory and activity in their store. You can imagine applications of many varieties, loss prevention or inventory management, omni-channel fulfillment. We are creating some of those to feed the market, but we are also working closely with partners to have them build a lot of these applications. And then the fourth level, as Anders mentioned, are what we would call solutions like our location solutions offering with the software as an embedded part of the total offering the customer doesn't really buy the software, the hardware, the service, but they buy a total outcome that is enabled by the software. Those would be the 4 that might characterize the business.

The next question comes from Jeff Kessler with Imperial Capital.

Can you talk a little bit about improving your customer experience so that your -- if you want to call it your length, your life with the customer and the dependence of that customer on you as a consultative partner becomes greater and greater so that essentially, there is very little reason and very little choice for them to move away from you. And I'm thinking certainly about things like the One Zebra programs, things that you are doing to combine both product but also your software and services that you've alluded to already to keep that customer much more sticky.

Yes. That's a -- so that's a big topic. That's kind of everything we do to some degree. But it's a good topic for us now also. From internal perspective, we have worked really hard for 2.5 years to go through the integration of the Enterprise business and to get off the Motorola's ERP system and get of all the TSAs. Now that we're done with that, I think we're taking a step back to make sure that we are now also offering the right customer experience. It's very important to us that our customers and partners see that we are a -- the best partner for them to work with across a variety of different ways. So we're mapping out little bit of the customer journey. You know, different touch points we have with customers and how can we make that all better. But some of the bigger ones that we have, I would say, is around our channel program. That's something that's going to be foundational to how we engage with our partners and ultimately, with our end users. And that's been well received by the market and -- but it always -- it's a live document. We always keep looking at how we can make it even better. We have our services engagements, which is a very important part of it also and we always work on making sure that we can deliver services that meet or exceed the service level agreements we have with our customers across the board. Also, no small part is the portfolio of products we have, right? We have the right solution to address our customers' needs, and software and services are certainly a part of that. So this is a very broad thing for us and that we -- something we've taken very seriously. We do look at our net promoter scores and try to drive those up every year to make sure that we are delivering that kind of experience that our customers should be expecting from us.

And that's kind of what I was driving at, while the Net Promoter Score is just a number. It's more than a number when you compare it against your peers.

Yes. And it's -- to us, it is a number, but it helps us dig into various aspects of other questions there to identify where we might have some weak spots and try to make sure we come up with kind of a closed-loop engagement where we go back to those customers and partners and explore what it is they are less satisfied with and make sure we have a good response and we can then modify if it is a program issue or some other performance issue or whatever it is we're doing that isn't fully meeting the mark.

We actually have a very disciplined and broad-reaching program around NPS in the company that the sales force is very engaged in. It covers both customers and partners. And we use it as a tool to then dig into where do we have opportunities to improve on an ongoing basis. So NPS for us is a core metric.

And is Android education, Android spending on customers a part, a big part of getting them used to a new system that they might not normally consider to be in their best interest at the beginning where it could be a better -- it could be in your interest to keep them on longer once they get used to it?

I'm not sure if I fully understand the question.

I'm thinking of the amount of time you're spending on adapting the customers and getting them to adopt Android so that something that is not maybe a little bit alien to them at the beginning becomes something that is more sticky to them in the end.

Yes. To that point, we do have significant training, educational material that we -- so we go out and engage with our -- through, say, first our distribution partners to help train a lot of our resellers to get -- make them comfortable in understanding the value proposition of Android versus Microsoft or other operating systems and understanding our portfolio and how that -- where it makes sense to position it. And similarly, we do have with end-user customers too. We have a number of partner advisory councils and end-user councils where we also discuss how can we best do those things. But we see it as the market leader as part of our job is to educate the market on the direction we see and how it's developing.

But I would see the dynamic around Android in regards to stickiness a little bit different than you described, right? So we are working hard and moving aggressively to get customers onto the Android platform for the well-known reasons around that. Now when the customer decides to go to the Android platform, we -- currently, we do have an advantage in doing that. We have a broader portfolio. We have very well-performing products. We have a great set of tools and capabilities around those. But we have to be also aware of the fact that Android is not exclusive to us, right? Android is open in the market, and therefore, once a customer moves to Android, then also other Android competitors can go and pursue that. That means for us, we have to stay ahead and it's our strategy to stay ahead through the value-added that we have been talking about, right? Superior Android environment, better security, better operating environment, software capabilities and services that's around that. That's the way that we can then keep the customer sticky to our solution once they make the Android transition.

To that point, we introduced LifeGuard. I think it was in beginning of Q2. That is an enhanced service for our Android devices where we can provide security patches and other bug patches for the life of the device. So otherwise, if you think of more into consumer world, that tends to be you support the current and then maybe 1 or 2 older versions of the operating system. We are supporting much further back because we know that our customers are expecting to use those products for much longer. It is not a throw-away product that can be in the market for 5 years. And we want to make sure that we can provide the similar level of service for them throughout the use of those devices. And that's a differentiated offering that makes it very sticky.

The next question comes from Jeremie Capron with ROBO Global.

I would like to ask about pricing trends. To what extent is pricing a positive factor on your margin trajectory today? And is this something that you see as sustainable, particularly in the context of the strong cycle of new products that you just gone through?

Yes. So pricing, as we said earlier, we are in a competitive market. We have to be thoughtful about how we price. We certainly always try to make sure we have a disciplined yet very flexible approach to that. We don't want to lose deals on price, but we certainly don't also want to win deals on price. We are always striving to have a premium for our products. We think that they -- we have the best portfolio in industry. And as such, we should have a premium to other competing solutions. It is our understanding and belief based on the market research we do that we tend to have a premium. No, it's not infinite, but there is a premium. And we work very hard to make sure that we are very thoughtful about how we price and how we make sure that we offer our customers a fair and attractive offer, but also one that allows us to continue to invest in the business and generate a return for our shareholders.

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

Thank you all for joining the call. Have a great day.

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