Zebra Technologies Corporation (ZBRA) Q3 2024 Earnings Report, Transcript and Summary

Good day, and welcome to the Third Quarter 2024 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

Good morning, and welcome to Zebra's third quarter earnings conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed on our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-on-year and on a constant currency basis. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with a discussion of our third quarter results. Nathan will then provide additional detail on the financials and discuss our fourth quarter and revised full year outlook. Bill will conclude with progress on advancing our strategic priorities. Following the prepared remarks, Bill and Nathan will take your questions. Now, let's turn to Slide 4, as I hand it over to Bill.

Thank you, Mike. Good morning and thank you for joining us. Our teams executed well in the third quarter delivering sales and earnings results above the high end of our outlook. For the quarter, we realized sales of almost $1.3 billion, a 31% increase compared to the prior year, and adjusted EBITDA margin of 21.4%, a 980 basis point increase. Non-GAAP diluted earnings per share of $3.49, which was 4x the prior year and delivered strong free cash flow. As we discussed on our last earnings call, during the second quarter, we began to see early signs of recovery across our end markets with mobile computing returning to growth. In the third quarter, we were encouraged to see the recovery broadened with data capture and printing also returning to growth. We realized double-digit growth across all our primary end markets and broad-based growth to customers of all sizes as began to cycle significant destocking activity in the second half of last year. We are seeing indications of customer spend generally improving in the second half, including expectations for higher year-end spending in North America and EMEA across most end markets. That said the manufacturing sector is still lagging as the goods economy continues to recover. Additionally, as we look ahead to 2025, visibility remains limited regarding the timing of large deployments. Another highlight was our improved profitability, primarily due to improved gross margin driven by volume, leverage, and business mix. With the recent consolidation of our North American distribution centers into a single Chicago area facility, we have successfully completed our restructuring actions to deliver $120 million of net annualized operating savings. Given our third quarter performance, improved momentum in demand recovery, and our focus on profitable growth, we are raising our full year outlook for sales, profitability, and free cash flow. I will now turn the call over to Nathan to review our Q3 financial results and discuss our revised 2024 outlook.

Thank you, Bill. Let's start with the P&L on Slide 6. In Q3, total company sales grew 30.6% reflecting continued recovery in demand across our major product categories. Our Asset Intelligence & Tracking segment grew 25.8%, primarily driven by printing and RFID. Enterprise Visibility & Mobility segment sales increased 33% with strong growth in mobile computing and data capture solutions. Our services and software recurring revenue businesses grew 4% in the quarter. We realized double-digit sales growth across our regions. In North America, sales grew 22%, led by mobile computing and printing. EMEA sales grew 47% with strength in Northern Europe. Asia-Pacific sales grew 24% led by momentum in Southeast Asia and India along with stabilization in China. And sales grew 42% in Latin America with particular strength in Mexico and Brazil. Adjusted gross margin increased 430 basis points to 49.1% due to volume leverage and favorable business mix and adjusted operating expenses as a percent of sales improved by 580 basis points. This resulted in third quarter adjusted EBITDA margin of 21.4%, a 980 basis point increase versus the prior year and a 90 basis point sequential improvement from Q2. Non-GAAP diluted earnings per share was $3.49, a greater than 300% year-over-year increase. Turning now to the balance sheet and cash flow on Slide 7. In the first nine months of 2024, we generated more than $650 million of free cash flow as EBITDA improved and we continue to drive significant improvements in working capital. We ended the quarter at a 1.6x net debt to adjusted EBITDA leverage ratio, which is within our target range. We resumed share repurchase activity in Q3 and now have increased flexibility given our improved cash flow, lower net debt, and $1.5 billion of capacity on our revolving credit facility. Let's now turn to our outlook. We entered the fourth quarter with a solid backlog and pipeline of opportunities and expect sales growth between 28% and 31%. This outlook assumes continued recovery across our major product categories with an improved level of year-end spending by our customers including several large North American retail projects. We continue to cycle easier comparisons across the business due in part to significant destocking activity by our distributors during the second half of last year. Q4 adjusted EBITDA margin is expected to be approximately 22% and non-GAAP diluted earnings per share are expected to be in the range of $3.80 to $4. Our fourth quarter outlook translates to full year sales growth of approximately 8%. Our full year adjusted EBITDA margin is expected to be approximately 21% and non-GAAP diluted earnings per share is expected to be in the range of approximately $13.30 to $13.50 based on our Q4 guide. This represents stronger profitable growth than our prior outlook supported by increased momentum and demand recovery and continued focus on our cost structure. Free cash flow for the year is now expected to be at least $850 million. We continue to drive profitable growth while improving our working capital levels including rightsizing our inventory. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill.

Thank you, Nathan. Turning to Slide 10. We remained well-positioned to benefit from secular trends to digitize and automate workflows with their comprehensive portfolio of innovative solutions including purpose-built hardware, software, and services. We empower frontline workers to execute tasks more effectively by navigating constant change in real time to advance capabilities including automation, prescriptive analytics, machine learning and artificial intelligence. Zebra continues to demonstrate market leadership through innovation. We have consistently reinvested approximately 10% of our revenues into research and development to advance our vibrant core and bring new innovative solutions to market. At recent customer events we hosted in North America and EMEA, we unveiled solutions that underscore our commitment to innovation. These include the latest version of our work cloud software utilizing advanced AI and machine learning and new rugged tablets for demanding environments. We also highlighted a Zebra kiosk solution offering self-checkout including tap-to-pay capabilities, which enhance the customer experience and enables frontline associates to focus on higher value tasks. This launch enables us to expand Zebra's addressable market with near adjacent technology that leverages our core software platform. Additionally, we are developing a generative AI mobile computing solution designed to assist frontline workers with sales, merchandising, and operating procedures, which we will feature at the National Retail Federation Trade Show in January. As you see on Slide 11, our customers leverage our solutions to optimize workflows across a broad range of end markets. We empower enterprises to drive productivity and better serve their customers, shoppers, and patients. Our relentless focus on innovation continues to drive our competitive differentiation and secure wins. In the second half of this year, we're seeing momentum in large Zebra deployments in North America and EMEA across retail, e-commerce, and logistics. Our customers are beginning to increase investment in our solutions as they absorb the supply chain capacity they built out during the pandemic and look to drive increased productivity. Recent key wins include a technology modernization project at a large e-commerce customer, a mobile computing upgrade at a large retailer to enable the latest software applications, a grocer's initiative to replace desktop computers with our mobile devices to drive several front of store use cases and a luxury retailer will deploy work cloud software to optimize in-season pricing. Additionally, logistics customer in EMEA selected Zebra's new wearable mobile computers to replace a competitor's voice picking solution. This customer expects to improve accuracy and increase employee and customer satisfaction with our solution. Last quarter, I highlighted our success and traction in selling the benefits of enterprise grade devices in healthcare. Our ease of integration into electronic medical record systems has been a competitive differentiator and we recently secured mobile computing and printing wins at large North America hospitals. Our solutions will improve workflows and enable enhanced visibility and tracking of assets, equipment, and specimens. Now turning to Slide 12. We realize double-digit sales growth across all vertical markets as demand recovers. Our confidence in sustainable long-term growth is underpinned by several themes that we expect to drive investment in our solutions including labor and resource constraints, track and trace mandates, increased consumer expectations, and the need for real time supply chain visibility. In closing, we are seeing the broadening of demand recovery in the second half of this year with a more normalized seasonality in sales volumes as we enter the fourth quarter and into 2025. As we look longer-term, we maintain strong conviction in the opportunity for Zebra as we elevate our strategic role with our customers through our innovative portfolio of solutions. Our sales and cost initiatives have positioned us well for profitable growth as our end markets continue to recover. I will now hand it back to Mike.

Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up to give everyone the chance to participate.

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Andrew Buscaglia with BNP Paribas. Please go ahead.

So it's a, obviously demand seems to be picking up quite a bit facing some easy comps. But also you had some commentary around some larger North America retail project wins, I believe, if you could comment on that. What are you seeing in that market specifically and how do you see that playing out into next year?

Yes, Andrew. I would say that, certainly, we're seeing that the quarter ended where we were pretty happy with the results and ultimately the teams executed well. I would say that we saw a broadening recovery across all vertical markets, not just retail, in Q3, which certainly was encouraging. From a retail perspective, I would say retail and e-commerce outperformed across all product categories, really in Q3, and we expect that to kind of extend into Q4, as you mentioned easier compares from a year ago. But we've also been able to see some year-end spending, which injects some more -- some normalized seasonality, which we have seen in past years, certainly year-end with larger orders from e-commerce, retail and transportation logistics, specifically North America and EMEA. So this is what we'd normally see at year-end. We hadn't seen that last year, of course, and now, we're seeing that, that return to more normalized levels. So we feel good about retail customers beginning to spend again. Sure, their focus continues to be investments in e-commerce, omni-channel continue to drive that market. We've got a solid pipeline of opportunities as we enter Q4 and we continue to win in that market against competition as we've got a differentiated portfolio of hardware and software serving the retail market. So we feel good about what we're seeing across retail in Q3 and Q4 and the seasonality coming back where we see some year-end spending across North America and EMEA. So we feel pretty good about retail at the moment. It was the first to recover, right? If you think back to the beginning of the year, retail was the first to decline and the first to recover. And we're seeing that continue across retail throughout the year.

Yes. Okay. And then can you just comment on what you're seeing with distributors and how are they going about their decision to start to restock and what kind of trends are you seeing in with those customers?

Maybe I'll start and hand to Nathan. I would say overall that our distributors are seeing the uptick in business that we're seeing from our partner community. I think that we're working closely with them to make sure that they've got the right level of inventory to meet the increase in demand as we enter Q4. But that we continue to work closely with them to make sure that across all product categories that we make sure that they've got the right level of stocking across each of the regions around the globe.

Yes, I think that's checks in, and again, when we look at it from an inventory perspective, they're at a good amount of days on hand in terms of where we'd like them to be entering the fourth quarter. So again, I think we feel, as Bill said, good about the overall inventory position here as we enter the quarter with the expectation for the year-end spend to come through.

The next question comes from Jamie Cook with Truist. Please go ahead.

Hi, good morning. Congrats on a nice quarter. I guess, just back to the large orders, can you help us understand how much of the large orders did that help the third quarter and sort of what's implied in the fourth quarter and your confidence level that this continues into 2025? And then, I guess, my second question, the margins over the past two quarters, I mean the gross margins were 49% plus, that's implied 49% or so in the fourth quarter. I'm just wondering, based on the sales volume and benefits from some of their structuring, the expectation that margins can at least be at that level in 2025, given the exit rate for 2024. Thank you.

Yes. So Jamie, maybe I'll start and then hand over to Nate around margin. I'd say if we kind of look back right to 2023 and kind of recap where we're at, right? I would say overall that customers in 2023 were absorbing capacity and that they built out in the pandemic. We clearly were -- they were scrutinizing budgets, sweating assets, right, and that drove significant distributor destocking in that timeframe. And in fourth quarter last year, we saw really no large deal, no larger order activity in the end of fourth quarter of 2023. So I would say that that's what's really different this year is that ultimately as we entered 2024 in the first half, we saw early signs of recovery really in mid-tier and run rate businesses we talked about in the first half and really focused on mobile, computing and retail. But larger orders really remain below historic levels in the first half. As we got into second half, what we're seeing is broader recovery across all regions. In most end markets, we're still seeing manufacturing for instance lag, but we're seeing the return of year-end spending and larger orders by retail and logistics customers in North America and EMEA. We're also seeing some probably mid-tier orders; I would call it from healthcare. So healthcare has also been a strength, which has allowed us to raise our guide. So I think more normalized seasonality that we're seeing where typically fourth quarter is an uptick in demand as our customers spend more in the fourth quarter as they move into next year. I would say the other thing we saw was that a comment on kind of large orders was probably the fact that we saw CapEx increase throughout the year. So I think as customers got more confidence in the macro environment around them and what we're seeing across their business, the increased capital spending, especially in retail throughout the year and injecting again more seasonality that we expect to happen in fourth quarter and then continue injecting seasonality back into our business in 2025. I'd say from a 2025 perspective, while we're clearly not guiding to 2025, we're optimistic that the recovery continues into 2025, certainly based on the strong second half. We'd expect again normalized seasonality to really be injected back into the business in fourth quarter just like we'd expect in 2025. So I'd say the one caution would be we're seeing a little bit of uncertainty across the customer base. And I would say that what that means is really manufacturing lagging the other segments. I would say, each customer is in a different phase of whether its refresh or new, product investment or new investment across their business and new applications. We're seeing some T&L customers' still absorbing capacity. So we've got a bit of limited visibility to large projects on when they're going to happen in 2025. So again, we'd expect the recovery to continue but a bit uneven across some of the end markets is the only thing I'd say from a caution perspective. Maybe, Nate can comment on margins.

Yes. Yes. So Jamie, if you look at our gross margin in the third quarter, just over 49%, that's the highest gross margin we've had in recent history. But really benefited from lower large deal volume, obviously, there was a bit of a return, but still lower than as a percent than what we've seen historically. But good scaling on our fixed infrastructure. We completed the consolidation of our distribution centers in North America. That was the last piece of our restructuring actions midway through the quarter, so seeing that benefit flow through. The only thing I'd say is you look at what's implied in the Q4 EBITDA guide. We do expect a sequential decline in gross margin just as you know, again, based on the incremental large deal volumes coming through on the higher volume. And I'd say that's still kind of the wild card if you look into 2025 is, what that large deal mix look like as we enter the year and as we go throughout the year, as we think about the kind of the gross margin dynamics.

The next question comes from Damian Karas with UBS. Please go ahead.

Hey, good morning, everyone. Nice work in the quarter.

Thanks, Damian. Good morning.

Yes. So you guys mentioned that you still have limited visibility around large deployments. Could you maybe just give us a sense for like why that is and when you think about going into year-end and some of these kind of late CapEx budget type decisions, is there what have you baked into your guidance? Are you only kind of factoring in COGS these larger deployments where you do have visibility? And is there potential that after we get through the election there could still be some kind of later year spend?

Yes. I would say, Damian, we feel good about the fourth quarter guide with a pipeline and visibility in all size orders really to support the guide. So I think we feel good about the guide for fourth quarter. I would say, overall from a limited visibility perspective, I think as we look into 2025, what we saw in 2024, was customers start off with kind of a conservative view on CapEx spending and kind of ramp that spending through the year. We'd expect that same thing to likely happen in 2025 is, look, I think overall there's lots of positive momentum from a macro environment, whether that's positive GDP, whether that's e-commerce growth, the capital spending increase, as I said throughout 2024, IT device spending is projected to be up in 2025. So that's all good news for 2025. But I think you mentioned it, right, all the other things that are kind of weighing on the macro around the globe, including U.S. elections, right, interest rates are still high. Inflation, impacting consumers and their spending overall, which then creates a bit of caution on the part of our customers, longer sales cycles, more approvals, those kind of things as they kind of second guess their CapEx. So I'd say overall, just while we see projects for 2025 at the moment, it's a -- it's just a bit early to have the visibility especially into large deployments and when they'll actually happen throughout 2025 given that we've seen kind of the slow CapEx release in 2024. So I think we feel good about 2025. We feel really good about our guide for fourth quarter, but there is still uncertainty out there with a lot of things happening from a macro environment.

That makes sense. And then, I was wondering if you could maybe just give us an update on the machine vision business. Is that still a drag on your financials at this point or maybe starting to see some signs of improvement there?

I'd say that we still feel good about machine vision overall as being closely adjacent to our scanning portfolio overall and creating opportunity for us as our customers continue to look to automate supply chain and visibility across manufacturing from an inspection perspective and transportation logistics from a visibility perspective within their environment. And I think that -- look, machine vision declined in the quarter. I think overall weakness in manufacturing has affected that market clearly. A good example of that would be electrical vehicle manufacturing kind of slowed. We saw our semiconductor, which were kind of heavily weighted to, and that's been one of our objectives all along is to diversify the business, the acquisition of Matrox beyond semiconductor. We've seen stabilization in semiconductor in the quarter. So that's a positive sign. We are pleased with the software growth to machine vision in the quarter. And we feel good that the diversification efforts we're working on to diversify outside of semiconductor into broader manufacturing, into T&L will benefit us as the markets recover. And I think that ultimately, we feel good about the opportunity for not just software but our continued investment across go-to-market and some new investments around AI and deep learning that will benefit us as that market returns. So tough market at the moment, but we feel good about the long-term prospects of machine vision.

The next question comes from Tommy Moll with Stephens. Please go ahead.

Good morning, and thank you for taking my questions.

Hey, Tommy.

Hi, Tommy.

I wanted to start on the large order topic. I hear you loud and clear that the visibility on next year remains limited at this point. And then, my question is, what would a typical planning cycle look like? And in a normal year, however, you want to define that for large orders, how much advance notice do you have, and when did the conversations really start to pick up where you get that kind of visibility about what's coming? Thanks.

Hey Tommy, I'd say typically six months. We typically have six months of visibility to larger projects from our customers. And I would say that then that planning cycle ultimately begins six months in advance as they think about what's the next-generation of device. What are the use cases they're using devices for? Are they -- the upgrades are always in the larger projects are always bigger than the last refresh, right, as they deploy more devices, they've used more use cases and typically when our customers refresh, they also look to add additional use cases along the way. So all that gets discussed six months plus in advance, and then they go through their process of selecting what product, what solution, what vendor and then move forward. And then the ultimate timing of the project and when it gets ordered and deployed, sometimes relies on other factors, like they're rolling out new software on their side, for instance, in working with outside vendors to do that or whether they've got internal developments happening or they've got a rollout schedule, they want to go meet based on their seasonality of their business. So that all depends from a rollout perspective. Sometimes they get delayed, sometimes they move faster. But typically six months of the visibility, and I think I would say -- at the moment, we saw CapEx ramp through 2024. We kind of expect that in 2025. In first quarter, we typically get more visibility to the first half projects in 2025. And then they typically move along through their process.

The next question comes from Brad Hewitt with Wolfe Research. Please go ahead.

So as we think about next year, aside from the year-end retail spending, are you seeing anything in the pipeline or the conversion rates that makes you more optimistic than you were last quarter about large orders returning in a more meaningful way in 2025? And then how much of a recovery in large order rates do you think we need to see for growth in 2025 to be in line with or better than your long-term growth framework?

Look, I'd probably say that, again, we're trying not to guide for 2025. I'll give you a little bit of color, right? Certainly, we're optimistic is the recovery. We expect to continue into 2025 based on the strong results we've seen in the second half of the year and the continued ramp of CapEx by our customers. We've seen a bit of uneven results into the marketplace, right? Retail, first to recover, continue that recovery. T&L green shoots in the second quarter now broader T&L recovery, but a bit uneven, meaning some customers are still using the capacity that they've built out during the pandemic and still working through that, but we're seeing parcel volumes increased. Manufacturing, clearly lagging the other sectors. And then healthcare has been a positive over the last two quarters. But I'd say that while we've seen that, we also see some macro headwinds overall, which include all the challenges we've talked about already, manufacturing softness in China, limited budget visibility as we kind of get into 2025 as to when projects will happen across the business. So we'd see continued recovery into 2025 on the strength of the second half. And right now, it's just too early to have a lot of visibility into 2025 overall. We do believe that seasonality does come back into the business in 2025, though. So as we're seeing seasonal effects of large orders at fourth quarter, we would expect that seasonality to really be injected back into the business in 2025.

The next question comes from Keith Housum with Northcoast Research. Please go ahead.

Good morning, guys. Bill, perhaps you provide a little bit of color from a geographical perspective. EMEA and Latin America were the standouts, obviously, this quarter. Was it a matter of easier compares for those geographies? Or is there something truly unique capping in those areas that perhaps we can think about as we go forward?

Yes, Keith, I'd say certainly double-digit growth across all major product categories, regions and end markets, right, was encouraging. But again, as you know easier compares with a weak Q3 last year. So an aggressive distributor destocking at that point in time. I'd say EMEA, clearly easier compares than the other regions. So I would say, we feel good about all regions overall. EMEA had a even easier compare than the other regions. But that said, I would say, strength in Northern Europe clearly within EMEA, some larger projects in T&L moving forward and some wins in mobile computing. I would say, across EMEA, manufacturing remains challenging, particularly Germany as an example. But I think that the story of EMEA is really easier comparison than the other regions. North America, I would say, improvement across all product categories, strength in retail, healthcare, T&L coming back, but a bit uneven as people are using the capacity, but the good news is we're seeing parcel volumes continue to recover. Manufacturing still a bit challenging overall and kind of lacking the other areas. Healthcare, two quarters in a row is our fastest-growing market. So that's returned to what we've seen in the past around healthcare, especially in North America. I'd say Asia, momentum in Southeast Asia, so Southeast Asia and India were kind of bright spots in the quarter. Stabilization in China, I'd probably say, and we're not expecting a near-term kind of recovery or growth driver from China overall at the moment. And I'd say Latin America strength in Mexico and Brazil, as you've kind of heard from us before. So I think we feel pretty good about recovery across all the regions. And I think the difference is more around vertical markets than it is the actual regions themselves.

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

Great. A couple questions. Just on the healthcare strength that you guys are seeing, is this new accounts that you guys are adding or just expansion of penetration or just kind of overall health and spend in that market after kind of some post-COVID hangover within healthcare so just more in-depth on healthcare? And then, second, I know a question was asked earlier just about some of the initiatives that you guys have enacted that had improved gross margins. But just as we think about OpEx into 2025, are there initiatives that are -- are all of the initiatives around some of the moves made earlier this year fully carried out? Or just how should we think about kind of OpEx into 2025? Thanks.

Yes, I'll start with healthcare and then hand over gross margin to Nate. I would say that from a healthcare perspective, a combination of new customers and refreshes across the portfolio, but continued opportunities across healthcare, I would say, we saw growth across all product categories. We have specific lines for printing, scanning, mobile computing specifically towards and focused on the healthcare market. I'd say, overall, we improved productivity and healthcare providers of all sizes really enhance safety and be able to take information and put it into electronical medical record systems, which is important across healthcare, not just in North America but around the world. So I'd say overall, this idea of automating workflows, collecting digital information on patients, assets, what's happening within the medical environment creates an opportunity for us in -- across all segments of healthcare. So whether it's clinical mobility or home healthcare, virtual care, all those have been opportunities for us. So I would say healthcare is our smallest vertical market at the moment and -- but it's the fastest growing in opportunities, both new and expansion across healthcare and not just North America, but global opportunities as well.

Yes, Meta, just when you look at it from an OpEx perspective, I'd say a couple of things. One, the full benefit of the restructuring is really embedded in the OpEx for the second half of the -- in the P&L. Really the incremental gross -- incremental restructuring benefits to go are primarily in gross margin and really related to the flow-through of the closure of the DC in North America. So the team is really now focused on how we scale and drive productivity across the OpEx infrastructure that we have. And there's some really exciting things that teams are working around the use of AI to drive productivity in terms of supply chain forecasting, order management or how we leverage generative AI for technology support, software code generation, again, all allowing us to scale on the -- and drive efficiency of what we have today. So I think that's really the focus is scaling on the structure that we have today with the tools and technology that are available.

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

Good morning. Thanks for taking my questions. First one is just around the cadence of demand recovery that you saw the timing of demand recovery that you saw in the third quarter because that is just the tone is a lot different today I think in the second quarter, it's a lot different even from touching base with you during the third quarter. So I'm just wondering, did you see an incremental pickup in demand in some of the end markets even as recently as October?

Hey Brian, let me start. I think, one, if you look back at our prior guide, we really assumed a similar level of demand from Q2 continuing into the second half with only really a modest increase for year-end spending. And what we wanted to see was the real commitments the POs starting to come through from our customers before embedding that in the guide. And I think that's what we saw through the second half of the third quarter and here in the early part of the fourth quarter. So really the conversion of that pipeline coming through, which is what we wanted to see to have the confidence to raise the guide as we are today. So I think that's really the difference. It's just that conversion of the pipeline really picked up in the later part of the third quarter and here in the early part of the fourth quarter where we had the confidence based on those commitments from our customers to raise the guide for the full year and see that year-end spend start to really come through here in the fourth quarter.

Okay. That certainly makes sense. And then second question, depending on the outcome of the election here, it could be -- there's a concern that there could be significant tariffs that start to go into place. And I know that in the past Trump administration, you've established a tariff task force. And I'm just wondering if you could describe what the activity that's happening at Zebra right now to potentially position for that environment?

Well, too early to speculate on the impact on all the various scenarios that could come out of next week's election. But we have been focused on some of the new tariffs that have been planned for 2026 and how we build alternatives so we can respond accordingly. So the team is actively working on mitigation plans for some of the new tariffs that are coming into place. And we continue to work -- actively work with our supply chain partners. We've been doing this since 2019 to diversify the supply base to improve resiliency overall as well as prepare for any future tariff changes. So I'd say right now, it's various scenario planning of what the different options could be, but our primary focus has been improved overall resiliency of our supply chain, so that we can respond, whether it's tariffs, geopolitical or natural disasters, how we make sure we have that structure in place to respond accordingly, that's really been the focus of the teams. And then obviously, depending on the outcome of the election and policies coming from that will respond and pivoted accordingly.

The next question comes from Rob Mason with Baird. Please go ahead.

Hi, good morning. The commentary around the gross margin has already been touched on and is performing really well. I'm just curious; again, we're still somewhat early in the recovery. I'm sure business is competitive. But has there been any change in Zebra's promotional practices as we've gone about the recovery? Do you need to discount less either just from your leadership position, the way you've built out the portfolio? Or anything that maybe structurally could carry forward from a promotional aspect?

Yes, Rob, I'll take that. I would say that overall, look, our strong customer relationships, the deep vertical market expertise we have across each of the vertical markets we serve, the breadth and depth of the solutions portfolio that's tailored to each market. I gave you an example before around healthcare, truly differentiates us from our competitors. And clearly, that our competitive advantages being the market leader around scale and investment in technology, our partner community around the world all gives us strength. And I would say that we really haven't seen really any meaningful change across the competitive landscape. I would say, we're confident that we continue to win in the market and that we'll continue to extend our industry leadership through our investments in innovation. We talked about early on in the call. And continue to strengthen our strategic relationships with customers. So we really haven't seen much different from a competitive landscape perspective around the world at the moment, pretty much of the same.

I see. Yes. And just as a quick follow-up. We've talked about mobile computing leaving this recovery. Can you give any perspective just on how data capture and printing may follow that, whether you're starting to see -- and then, now, we had good year-over-year growth against easier comps? But are you starting to see accelerating momentum in those products as well?

Yes, Rob, I think that again, as you said it, mobile computing was kind of the first major category to recover in Q2, and we're continuing to see broad-based demand for mobile computing in Q3 and into Q4 and then some of these larger deal activity really driven by mobile computing. But I'd say what we saw in Q3 was really broad-based growth across DCS, including all product categories within DCS and then across all regions. So I think that's a good sign. And we'd expect that strength to continue into 2024. Again, there's been more variation in the first half of the year on print in DCS around supply chain not being available in 2023 and then recovery in 2024, and all the variations around it. But I think we're seeing growth in DCS, same in print. So growth across most print categories -- one of the strengths has been particularly mobile print. So again, ties back to mobile computing, right, strength across that. There's no opportunities in print. I would say things like eco-friendly linerless printing, so the idea that less waste is creating new opportunities within print. So we feel good about the broad-based growth across DCS and print. I would say me the last area may be worth mentioning because it hasn't come up yet is RFID. So strong growth in Q3 across RFID as we continue to see broad-based adoption of RFID in the quarter.

The next question comes from Jim Ricchiuti with Needham. Please go ahead.

Hi, good morning. This is Chris Grenga on for Jim. Thank you very much for taking the questions. Just to follow-up on that RFID point. There have been reports about new applications for RFID in grocery, first use case apparently being one involving bakery departments. First question is whether you might anticipate new opportunities for your RFID printing business as a result of these developments? And second, more broadly, how do you view the RFID growth opportunities over the next year and whether grocery could be a meaningful use case to go along with what we're seeing in apparel, general merchandise, and logistics?

Yes. I would say that strong growth in Q3 for an RFID perspective and strong pipeline of opportunities across retail, T&L, manufacturing. As you said, Chris, broadening and retail beyond what was originally apparel into general merchandise and now an opportunity that we've seen for some time and it's been worked on across the industry as things like fresh, right, within the retail store and around the outside perimeter of the store where you see fresh goods and leveraging RFID there. So I think that clearly represents an opportunity for us, track and trace across supply chains, parcel, tracking, healthcare, all those also create an opportunity from Zebra's perspective, we've got the broadest set of RFID solutions, including fixed and handheld readers, industrial and mobile printing, our software and labels to go along with that. So we feel good about the opportunity and the broadening of the opportunities out of RFID beyond, as you said, apparel and retail. I would say the exciting piece that everybody is looking at in RFID is the tag adoption, right, and the growth of tags and those items that are source-tagged or tagged within a retail store, for instance, or a parcel inside T&L, the more items are tagged, the more readers there's more, the more applications there are and that allows more automated collection of information. So I think ultimately, we're excited about the RFID market and continues to grow, and the pipeline of opportunities and applications continues to grow as well.

The next question comes from Joe Giordano with TD Cowen. Please go ahead.

You touched on tariffs and what you're doing? Can you just remind us like how much -- I know you guys moved with your manufacturing partners moved a lot of stuff out of China last go around. Can you update us on like where we are and how much production is still there? Or how much can be moved, if necessary? And how much is like structurally has to be there?

Yes. So we -- if you look at an aggregate in terms of dollars, it's almost close to 50% of finished goods production is outside of China, still a vast majority of the component supply chain remains within China, and that's really the trickier or more stickier part of the supply chain to move just given how embedded it is within that market. So again, we moved a significant portion of the manufacturing up really to support North America into places like Malaysia, Vietnam, back in 2019, that's continued to ramp over the last several years. But I think it's important to note, we didn't move all North American volume out of China. Some products, just given the relative volume or the return on investment still made sense to produce in China for the North American market, even with the higher tariffs. So that's, again, the inflation, and we offset that with higher pricing, the pricing actions we took back then. So that's the equation we're working through now, which is what more can be move, should be move, if and when any additional tariffs are enacted. So that's what the team is scenario planning out, but also I want to make sure we make the right business decision that gives us long-term resiliency as well as follows where the supply chain is going because we do rely on, again, components and subassemblies and making sure that we're not too far dislocated from where the those source components are coming from. So it's a pretty complex equation that the team is working through. But we're lucky that we have supply chain partners that in and around the region that we work with to work and solve that challenge.

Okay. That's helpful. Thank you. And then just I want to make sure I understand the seasonality discussion around next year. And I know you mentioned you don't want to give 2025 guidance. I appreciate that. And normally, your first quarter is a step down versus the fourth quarter. But now we're in a situation where like big orders aren't hitting in the fourth quarter, so like is it unreasonable to think that you just have kind of a continued moderate increase quarterly as you go through next year? Or do you still get like a step down even without kind of the project activity in the end of this year?

I think based on what we said earlier, I think the expectation is to be pretty -- Q4 is maybe not back to a full recovery, but it's still -- there's been a pretty big step-up in what we saw from Q2 to Q3 and Q3 to Q4 with year-end spend. There is several large deployments within the fourth quarter. So I would -- that's why we said we'd expect it to be more maybe like a historical seasonality as you go into next year because of the year-end demand we're seeing and some of the large deployments here in the fourth quarter.

The next question comes from Guy Hardwick with Freedom Capital Markets. Please go ahead.

Congrats on the results, excellent performance. Obviously, Zebra has made great progress year-to-date in deleveraging, and I noticed that trade working capital has fallen materially as a percentage of sales. But now with the leverage ratio down at 1.6x, at what point do you return to making acquisitions? And how would you balance those up against share repurchases? I believe you return to share repurchases for the first time more than a year in Q3.

Yes, Guy, I think maybe just to start because we haven't touched on it. So obviously, the free cash flow for the year-to-date, over $650 million, almost $850 million higher than from last year. So just really tremendous work by the team on working capital improvements. We've reduced inventory year-to-date by over $160 million. So it's great to see the actions that we put in place starting to flow through in the reduction in working capital and seeing that come through free cash flow. So it really puts us in a great position exiting the year and going into next year. And as you mentioned, we returned to share repurchases in slightly here in the third -- back in the third quarter. And we're continuing to take a systemic approach to share repurchases here in the quarter and as we go into next year. But with the debt leverage ratio at 1.6x, which is on the low end of the target range, overall comfortable with the net debt cash position, but puts us in a nice position to really return to either returning capital to shareholders or as you mentioned, giving us capacity for M&A opportunities as they arise.

Maybe just some comments on M&A. Overall, I would say that, as Nate said, returning capital to investors through share buybacks or M&A is to really good uses of capital for us. I would say that our M&A philosophy hasn't changed. It's really -- overall, it's to leverage and advance our vision and our strategy moving forward is how we think about it. We target specific opportunities that are really closely adjacent and synergistic to what we do today. Clearly, as you pointed out, the strong balance sheet gives us optionality to return capital or look at opportunities within M&A. I would say that the bar is a bit higher today even with the increase in free cash flow from the idea of doing something larger certainly would entail higher interest rates. And there's still a bit of uncertainty out there from a market perspective. So if we were going to acquire something, we'd want to be assured kind of the revenue stream coming in. So a bit higher bar at the moment. I think we're excited about our business as it exists today. And I think that disciplined M&A is how we think about it as a vector for long-term growth that we can use in addition to returning capital to shareholders through share buyback. So both are an option. I think we continue to look and be inquisitive in the marketplace from an M&A perspective, but it's got to meet our strategic vision.

And Bill, just as a quick follow-up. I think in your prepared remarks, you referenced that the AI-enabled enterprise mobile computers will be showing -- you'll be showing those at the NRF show early next year. Does that mean that you are closer to commercialization, perhaps you would have thought just a few months ago when you -- we discussed this on the Q2 call?

Yes. We -- I would say, yes. So we demonstrated our early version of AI companion really on mobile devices at NRF last year. This will be a continued advancement along those lines at NRF this year, working closely with our partners of Qualcomm, Google and some of our customers to continue to advance that opportunity. I think that this idea of a digital assistant on a mobile device, assisting the frontline worker that will drive productivity and really elevate the customer experiences. And we see this as being running the large language model on the device without requiring connectivities to the cloud. You can have connectivity cloud if you want or not. And a lot of our customers don't have a lot of connectivity out of their environments, think of retail stores, think of warehouses and others. So that's an advantage. And I think it's something that we're focused on and likely in 2025, what we'll see is some type of commercial offering from Zebra. We're working through what that really means from us, but I think it bodes well for us moving forward from working closely with our customers, making sure we're understanding how they're using and building large language models and their data, how do they protect that, how do they upgrade that, how do they keep it current within the mobile devices, and we're working closely with them to make that happen. So I think, yes, we're getting closer, continue our investment there and continue to move ahead with the development cycle in that area. And we're going to show a refresh demo at NRF that takes kind of the next level this year.

Our last question comes from Brad Hewitt with Wolfe Research. Please go ahead.

Thanks guys for fit me back in. It looks like you bumped up the Q4 implied sequential revenue growth by about 200 basis points. But you took down the implied sequential incremental EBITDA margins a little bit. So curious if there were any mix benefits in Q3 that you do not expect to occur in Q4? And how should we think about the puts and takes of the Q4 EBITDA margin line on a sequential basis?

Yes, Brad, as you mentioned, so if you look at our EBITDA guide of 22%, it's up just over 0.5 point from -- sequentially from Q3, and again, primarily driven by the volume leverage. And I think the real change is just the deal mix overall with the higher mix of large deals and some of the large deployments in North America that somewhat of a drag sequentially on gross margin, driving that down a bit. And OpEx relatively flat just based on some of the project timing. So and the majority of any incremental gross margin on a sequential basis is embedded within gross margin. So I think that's really the -- no other kind of -- I think Q3 obviously came through stronger just seeing all the different actions flow through on the higher volume. And then the real change from Q3 to Q4 is just the mix within the portfolio.

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

Yes. In closing, I'd just like to say thank you to our employees and partners for their continued support and delivering strong Q3 financial results. It was about 10 years ago -- actually, 10 years ago this week, we closed the Enterprise acquisition. And I would say that our relentless focus on innovation and our continued commitment to our customers continues to drive differentiation for us in the marketplace and secure competitive wins. And I would say, we're well-positioned to advance our industry leadership as our end markets recover. So thank you. Have a great day, everyone.

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